The theory of marginal utility resolved the paradox of value which had been propounded by Adam Smith and which had prevented the classical economists from grounding exchange value in utility. “The things which have the greatest value in use,” Smith observed, “have frequently little or no value in exchange; and on the contrary, those which have the greatest value in exchange have frequently little or no value in use. Nothing is more useful than water: but it will purchase scarce any thing; scarce any thing can be had in exchange for it. A diamond, on the contrary, has scarce any value in use; but a very great quantity of other goods may frequently be had in exchange for it.”I'm not satisfied with the way this passage explains the issue (I don't think I have a disagreement with Reisman about economics here, though). It doesn't mention supply, demand and competition, which I think are crucial. It leaves a reader to wonder: why not charge the value of people's first quart of water? Sure you wouldn't sell the marginal 10,000th quart at that price (they'd find the price higher than the utility), but you could potentially make more profit, with less water inventory, at a higher price. The reason is because other water sellers would compete with you and that keeps prices down, not because of marginal utility. This answer's Smith's question about how something so valuable can be cheap.
The only explanation, the classical economists concluded, is that while things must have utility in order to possess exchange value, the actual determinant of exchange value is cost of production. In contrast, the theory of marginal utility made it possible to ground exchange value in utility after all—by showing that the exchange value of goods such as water and diamonds is determined by their respective marginal utilities. The marginal utility of a good is the utility of the particular quantity of it under consideration, taking into account the quantity of the good one already possesses or has access to. Thus, if all the water one has available in a day is a single quart, so that one’s very life depends on that water, the value of water will be greater than that of diamonds. A traveler carrying a bag of diamonds, who is lost in the middle of the desert, will be willing to exchange his diamonds for a quart of water to save his life. But if, as is usually the case, a person already has access to a thousand or ten thousand gallons of water a day, and it is a question of an additional quart more or less—that is, of a marginal quart—then both the utility and the exchange value of a quart of water will be virtually nothing. Diamonds can be more valuable than water, consistent with utility, whenever, in effect, it is a question of the utility of the first diamond versus that of the ten-thousandth quart of water.
Water isn't just cheap because of mariginal utility (the utility of the 10,000th quart is much lower than of the first quart, lowering demand after prior quarts of water are supplied), it's also because a large supply is cheaply available from nature. If the question is about starting a new business to acquire and sell additional water, than the marginal utility of water is the relevant issue. But if the question is about the cheap pricing of current water, I think prices would be raised (despite that meaning fewer quarts sell) if not for competition. (BTW I'm ignoring issues like government regulations and the real-life water situation, and just treating it as a free market commodity.)
If I'm mistaken about any of this, then I'd still say the passage's explanation is unsatisfactory, because in that case it apparently didn't adequately clarify matters for me.
Very soon thereafter, the whole Circle Bastiat, myself included, met again with Ayn Rand. We were all tremendously enthusiastic over Atlas. Rothbard wrote Ayn Rand a letter, in which, I believe, he compared her to the sun, which one cannot approach too closely. I truly thought that Atlas Shrugged would convert the country—in about six weeks; I could not understand how anyone could read it without being either convinced by what it had to say or else hospitalized by a mental breakdown.That Rothbard letter can be found here. I think it may be Rothbard's most interesting writing.
The following winter, Rothbard, Raico, and I, and, I think, Bob Hessen, all enrolled in the very first lecture course ever delivered on Objectivism. This was before Objectivism even had the name “Objectivism” and was still described simply as “the philosophy of Ayn Rand.” Nevertheless, by the summer of that same year, 1958, tensions had begun to develop between Rothbard and Ayn Rand, which led to a shattering of relationships, including my friendship with him.
I agree with Reisman that Atlas Shrugged should have persuaded the whole country in about six weeks. That it didn't is one of the largest and most important unsolved philosophical problems. (Note I'm thinking of this problem broadly. Why didn't Popper's work persuade more people? Mises? Szasz? Deutsch? I consider those the same issue. Atlas Shrugged is the best, but there's a lot of good work which should have persuaded a lot of people but has only had limited success.)
13. Cf. Murray N. Rothbard, For a New Liberty (New York: Macmillan, 1973). In that book, Rothbard wrote: “Empirically, the most warlike, most interventionist, most imperial government throughout the twentieth century has been the United States” (p. 287; italics in original). In sharpest contrast to the United States, which has supposedly been more warlike even than Nazi Germany, Rothbard described the Soviets in the following terms: “Before World War II, so devoted was Stalin to peace that he failed to make adequate provision against the Nazi attack. . . . Not only was there no Russian expansion whatever apart from the exigencies of defeating Germany, but the Soviet Union time and again leaned over backward to avoid any cold or hot war with the West” (p. 294).I already had a very low opinion of Rothbard. He has a lot of really awful views, such as anti-semitism and children-as-property. I didn't know this specific thing. (Some of his writing about economics is actually pretty decent.)
It is the division of labor which introduces a degree of complexity into economic life that makes necessary the existence of a special science of economics. For the division of labor entails economic phenomena existing on a scale in space and time that makes it impossible to comprehend them by means of personal observation and experience alone. Economic life under a system of division of labor can be comprehended only by means of an organized body of knowledge that proceeds by deductive reasoning from elementary principles. This, of course, is the work of the science of economics. [emphasis mine]I disagree with this epistemology, which thinks you have some foundations and deduce the rest. For info on my epistemology, see my David Deutsch and Karl Popper reading recommendations, and my own writing on my websites.
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