Thinking at the Margin: The Revolution that Killed the Labor Theory of Value

In this episode of Fascinating!, Rik from Planet Vulcan takes us on a journey through the marginal revolution—a seismic shift in economic thought led by the likes of Carl Menger and his brilliant contemporaries. By introducing the concept of marginal utility, these economists buried the labor theory of value and sparked a revolution that still shapes how Earthlings understand markets today. With playful wit, Rik unpacks how thinking at the margin changes everything, from the price of hot dogs to the mysteries of lost kites stuck in trees.

Along the way, we meet figures like Ludwig von Mises and Eugen von Boehm-Bawerk, who expanded on marginal thinking to explain interest rates and time preference. Rik explores how economists showed that incremental changes, not broad sweeping decisions, govern real-world outcomes. So, if you're still clinging to the labor theory of value, prepare to have your brain snacks eaten—marginally speaking.

Transcript

Good day to you, and welcome to Fascinating!  I am your host Rik, from Planet Vulcan.  My continuing mission on Planet Earth:  to search for signs of intelligence and to encourage its spread.

In this essay, we turn the spotlight of approval on a group of Earthling economists who exhibited remarkable intelligence indeed and whose ideas richly deserve to be spread.

I am speaking of the economists who initiated what is known as the marginal revolution.  This includes, first and foremost, the Austrian Carl Menger, who in 1871 published his “Principles of Economics”.  

Other key figures who contributed to the development of thinking at the margin include Leon Walras, William Stanley Jevons, Eugen von Boehm-Bawerk, Francis Ysidro Edgeworth, Vilfredo Pareto, and of course Alfred Marshall, whose marvelous 1890 textbook, also titled “Principles of Economics”, became the standard text in college courses in Economics for nearly fifty years.

The brilliant Ludwig von Mises and von Mises’ protégé Friedrich Hayek were the most important intellectual heirs of the marginal revolution in the succeeding generations of economists, and von Mises and Hayek employed the subjective theory of value to explain the evolutionary nature of an economic system, that is, the idea that order emerges in an economic system based on the preferences and actions of the individuals who comprise the system.

Menger, Walras and Jevons all independently introduced, at pretty much the same time, the idea of marginal utility, which is the basis of the now-dominant subjective theory of value.  The enormous explanatory power of the subjective theory of value put the last nail in the coffin of the labor theory of value, which such notables from earlier times as Adam Smith, David Ricardo and Karl Marx employed in their work.

To understand marginal utility, or marginal anything, it helps if you think of synonyms for “margin”.  These synonyms would include such words as boundary, border and edge, or Grenze in German.

The marginal utility of something is defined as how much one more unit of a good or service, in other words the unit at the margin, would add to total utility, also expressed as the incremental utility, or incremental satisfaction.

For example, think of the utility of a hot dog.  Let’s suppose that you have already eaten one hot dog, and you are considering eating a second one.  A rational decision maker would focus on how much it would add to total satisfaction to have one more hot dog, and the decision would then depend on a comparison of the subjective value of the incremental hot dog to its price.  You would eat the additional hot dog if and only if its subjective value is greater than or equal to its price.

Think also of the sunk cost fallacy commonly encountered among Earthlings.  “Sunk” means not recoverable.  A rational decision maker would ignore costs that cannot be recovered, and instead focus solely on marginal, or incremental cost, and compare the incremental cost to the incremental benefit, however defined, that would flow from the spending.

Someone who has been sidetracked from rational thinking by emotional impulses often thinks it is important to consider the sunk costs, and that the greater the amount of the sunk costs, the more important it is to keep going and incur more costs, as if that were a method of recovering the nonrecoverable costs.

Here's another example of thinking at the margin:  when is something considered “lost”?  Your first thought might be that something is lost when you cannot find it.  But what do you mean by “cannot”? 

Can you ever conclude with certainty that you would not be able to find the missing thing no matter how much additional effort you put into the search?  Perhaps there are rare instances where that might be true, but most of the time there is some degree of uncertainty about whether something can or cannot be found.  

A rule that would cover any situation is that something is considered lost when the incremental cost of recovering it would exceed the subjective value of doing so.

If your kite is stuck in a tree, you would declare it lost even if you could see exactly where it is, if retrieving it would be more costly than can be justified by its subjective value.

Learning to think at the margin is a marvelously useful tool in everyday life.  

By way of another example, let’s say you and your special pal are at a restaurant trying to decide between the $20 entrée and the $25 entrée.  The $20 entrée would be merely an okay meal, and the $25 entrée would be an especially pleasurable meal.  If you decide that you cannot afford to spend $25 on an entrée but you can afford to spend $20, you’re not making a rational decision.  This is because you are not deciding whether to spend $25, you are deciding whether to spend $5 at the margin.  If you order the $20 entrée you are still spending $20, but for $5 more you could go from a boring meal to a meal with subjectively greater value.  The question then becomes, is the difference between boring and exciting worth $5?

Once you catch on to this way of thinking, you will perceive opportunities to apply it many times a day every day, and your overall life happiness and satisfaction will improve markedly as you get more bang, in terms of utility, for your limited bucks.

We should probably address a question you might have about the labor theory of value, which I stated above had been slain in the 1870’s, and that it was the subjective theory of value that put the final nails in its coffin.

But if you have observed, you have to have noticed that a significant number of Earthlings in today’s world, many of them otherwise intelligent, still profess a belief in the labor theory of value, which refuses to stay in its coffin.

How is it that this undead notion, which anyone who gives it serious study concludes is far less sophisticated than the subjective theory of value, still wanders the land, eating brains?  Serious study would mean looking with an open mind, and in making all decisions in light of facts and reason.

And that seems to be the problem with so many Earthlings.  They feel at liberty to treat as optional the idea that you are supposed to change your conclusion when facts and reason contradict it.

Because the method that so many Earthlings follow is to begin by adopting the conclusion and then searching for confirmation.  If the reasoning and the facts do not confirm their conclusion, they dismiss the reasoning and facts, rather than the conclusion.

Some of the more ridiculous Earthlings amongst you even go so far as to argue that the insistence on using facts and reason is no more than a tool of oppression employed by a supposed ruling class, which is defined as anyone who insists on using facts and reason.  All quite circular.

And what we Vulcans have observed is that those Earthlings who do cling to the labor theory of value have decided, for reasons we find inexplicable, to begin with the simple, easy to understand wrong conclusion that all of Earth’s history and its present day are explained in terms of class struggle; and the idea that one person’s gain is inevitably another person’s loss, also known as the zero-sum fallacy.

This belief makes no sense unless it is the labor theory of value that is the more sophisticated one, and not the subjective theory of value.  So they seem to have elevated the labor theory of value to the status of dogma, and believe that disputing or even questioning this dogma amounts to heresy, or even worse, bad manners. 

It seems that the requirement of making sense is also just one more tool of oppression.

A thinking person can only conclude that these true believers are supporting the labor theory of value, and not that the labor theory of value is supporting them.  Without their tenacious commitment to this outmoded thinking, the labor theory of value would have withered away long ago.

In this context, the work of Eugen von Boehm-Bawerk is particularly illuminating.  This brilliant thinker is the one who came up with a theory that an interest rate if best conceived of as the price of credit, and like any price, it is determined by forces of supply and demand.  

He showed that the supply of credit depends on what he called time-preference for consumption, which means that most people most of the time would prefer to consume sooner rather than later, all other things being equal, which establishes it as a valid generalization.  

Time preference explains why people must be induced to defer consumption in the present (the definition of saving) by the prospect of greater consumption later by way of receiving interest on their savings.

The demand for credit is based partly on the fact that some consumers are willing to pay interest to enable more present consumption than they could manage on their present income, even if it will result in less consumption later, as their future income will be reduced by the interest payment.  Think for example of buying a home.

The demand for credit is also based partly on the value of capital, which reflects the additional production that is enabled by adding capital inputs, defined as man-made inputs to the production process.

How do Marxists attempt to explain interest rates?

They don’t.

They will tell you that interest is just one facet of the surplus value that the owners of capital extract from the laborers who are creating all the value, and that this stolen surplus value is divided among members of the capitalist class by internal squabbling, and the amount that is labeled interest, or dividends, or profit or something else is an insignificant detail that requires no explanation.

Deep, huh?

We should also take particular note of the profound thinking of Irishman Francis Ysidro Edgeworth, who created the vastly illuminating diagram called the Edgeworth Box.  The Edgeworth Box illustrates in the simplest terms possible the way that both sides of a transaction are able to benefit, producing a positive sum game.  The Edgeworth Box makes use of the idea of diminishing marginal utility, a highly plausible generalization for most people and most sets of goods.

You can find many discussions of the Edgeworth Box on YouTube.

I invite you to have a listen to the next Fascinating! podcast and a look at the next video on our YouTube channel, Fascinating@pregodenada.

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Live long and prosper.  

Savor your experiences; treasure your memories; anticipate a happy and rewarding future.  

And respect nature’s wisdom.