The bestselling and most widely used economics book in the UK in the early part of the 20th century was by Philip Wicksteed (1844–1927), a forgotten great thinker with a body of ideas that deserves revisiting today.
I read his book “The Common Sense of Political Economy” for the first time a few years ago, and its importance struck me at the time. Here is a treatise on economics written at the dawn of the discovery of a great principle of modern economics: marginal utility.
The volume is as mighty and significant as Adam Smith’s “The Wealth of Nations” but in many ways is better. It is not just a dusty old tome, but one that speaks directly to the great issues of our time. Its clarity exceeds any other presentation of the subject I’ve read. The author’s enthusiasm, even love, for the topic itself is obvious on every page. He is like a tour guide in a great castle who turns on lights in room after room and proceeds to explain everything with precision and excitement. The reader can detect this in his prose.
Why does he put the phrase “common sense” in the title? There are two intended meanings. He was seeking to bring a certain unity to the opinions and debates within economics at the time. The principle of marginal utility had been written about and taught for several decades. It was the great discovery of the last half of the 19th century within economic theory, and by 1900 it had achieved a broad consensus within the discipline. Wicksteed sought to make the marginalist way of thinking the “common” way.
The second way he uses the term attempts to capture the effect of marginalist thinking on the human mind. Once you get the principle, the functioning of the world becomes clearer to you. What was previously mysterious seems rather obvious. What had previously baffled you seems perfectly clear. The marginalist way of thinking becomes, in the most colloquial use of the phrase, “common sense.”
Wicksteed writes with the passion of a hobbyist (he actually served as a Unitarian minister as his day job) but with a precision that exceeded all the professional economists of his time. His work still stands as the most elaborate, detailed, and extensive exposition of the idea ever written.
If you stick with his argument from the beginning to the end, your thinking will be permanently affected. You will see marginal utility all around, in every economic action. It will provide new ways of thinking of prices and resources and human behavior. You will have an impenetrable edifice against the fallacy of thinking of the value of whole classes of goods and services, and instead will see value as exclusively attached to the incremental choice of the acting person.
What is marginalism? It was the discovery that economic value extends from the incremental choice, one unit at a time. Why does this matter? Let me give the nearest example at hand. I have a cup of coffee in front of me. I made it with a Keurig coffee maker. Each Keurig cup costs $1. Is that too much or too little? On the one hand, it is crazy expensive. I could pay $8 for a full can of coffee and make probably 40 cups and pay only 20 cents per cup.
Why don’t I do this? Because my choice is made at the margin. I’m not evaluating a whole stock of this good. I’m making my value judgments on just the one cup of coffee that I want to drink right now. This is the relevant unit, not some abstraction concerning how much coffee is at the store or on the ships coming from overseas or the whole stock of coffee growing in plantations all over the world. What matters to me in making the choice of whether the coffee is “worth it” is the cup right in front of me.
And this explains the enduring mystery of why people pay $7 to $10 for a cup of coffee at Starbucks that they could make at home for a tiny fraction of that amount. All purchases are made at the margin, involving the incremental good that is then available and not the entire class of goods in existence.
It’s the same with restaurants. It has surely occurred to you that you could make the same food at home for a fraction of the price. And the beer and wine sold there, especially these days, is always priced wildly over what the same good would cost at the store. This is not a ripoff. Everyone knows about this. The point is that people are paying not for the whole class of goods, but for the particular good at the restaurant, which includes the entire experience of being there.
This is why the profit margins of some goods are so high and some are so low. It depends on the intensity of demand that consumers have for the good at the moment of purchase. You might give up an appetizer or dessert because it is so expensive, but a beer drinker will not give up his beer.
This is why price analytics that are purely based on cost can be so misleading. Yes, a competitive market will drive marginal cost and price to identity over the long term and in a perfect model. But in reality prices are determined at the point of sale, not on some abstraction that lies outside the choices of individuals.
The classic puzzle that marginal utility sought to solve was this: Why are diamonds so much more valuable in the market than water, even though water is obviously more necessary for life? Just on the face of it, shouldn’t it be the reverse?
Marginalism solves the issue. The choice of one or the other is made on the incremental unit, not on anyone’s opinion of the value of the whole class of goods. From the point of view of human choice, water is usually far more plentiful and available than diamonds, whereas diamonds are much less so and therefore have a much higher value per unit.
The situation could reverse itself in a different social context. A man dying of thirst in the desert will pay far more for water than diamonds. This is how prices come to be: the choice at the moment of decision-making for or against the increment of what is available right now.
Marginal-utility theory solves many other seeming mysteries. Why are movies that cost tens of millions to make available for download for only a few bucks or even for free, while video games that might cost only a few thousand to make are priced at $50 and $100? The answer is that the user is making judgments based not on the cost of production, but on the use value of one unit to him or her at the point of decision-making.
Marginalism helps explain wage puzzles, too. Why do plumbers make so much more money than babysitters, even though babysitters are guarding and protecting human life and plumbers are only unstopping drains? The babysitter might indeed have great total utility to society, but the market makes judgments on the margin. Their services are much easier to come by, whereas plumbing services are relatively scarcer. Consumers do not care about total utility; they care about obtaining the service in the one instance in which they need it. That decision is what determines the price.
This insight further addresses wage issues that would otherwise remain mystifying. Why does a basketball star, who would seem to provide nothing necessary to human life, make so much more money than a reading teacher, who is teaching a crucial skill? Again, it is not the total utility of the task that matters for economics, but the utility of the incremental choice of the acting person.
Why are restaurants open on holidays whereas banks are closed, when surely banking provides a more unique service to society and anyone can cook at home anytime? The answer is that restaurants make higher profits on the margin on holidays, when people want to go out to eat, whereas the banks have discovered that their profit margins are best served by opening when people tend to do their banking, which is not on holidays.
Marginalism helps illuminate many other economic concepts, such as opportunity cost (the real cost of anything is the thing you give up to get it), subjective value (economic value resides in the human mind, not the physical good), diminishing marginal utility (the more of each additional unit you buy, the less you are willing to pay for it), and the relationship of cost and price (the cost of a good never dictates its market price; indeed, the reverse is true). It provides insight into nearly every aspect of human behavior. Once you begin to think about the margin, the scales truly do fall from your eyes.
Marginalism also reveals what is wrong with certain policy ideas, such as taxing unrealized gains in capital, which has been floated recently. Assessing such taxes requires placing value on a class of goods that is not being actively traded and thus not valued by real-world market actors. In that sense, such valuations are meaningless. If you have a fancy oil painting on your wall that is believed to be rising in value, should you be taxed more on it each year even though nothing has physically changed about it? That makes no sense.
Such a policy would end in driving down the value of all capital even without active trading. It would embed in all property a downward-trending valuation that would correct for the presumed higher taxes that would accrue should its valuation rise. This is a path toward mass capital losses, essentially a pillaging of value even without trading. Such a tax represents a complete repudiation of the idea of marginal utility.
You will notice that Wicksteed’s book is gigantic. But it is also a joy to read because his own enthusiasm is infectious. Maybe you will be like me and truly come to admire and genuinely like the man behind the prose. I appreciate his spirit of discovery and exposition. It’s absolutely marvelous that Wicksteed can speak to us again, fully a century and 14 years after his masterpiece first came out. It’s a big but worthy task to go on this tour of economic reality with him. Marginalism will become your “common sense” way to view the world once you’ve finished.
