Introduction

Economically relevant valuations are determined by the significance of the last unit added to or subtracted from the total.

Marginalism plays an important role in the development of market prices.

In an economic exchange, each additional item has less value than the preceding unit. This means that when a seller offers a number of the same goods to a buyer, the price per unit declines as the buyer acquires more goods. Each additional unit has less value to the buyer. He will therefore pay no more per unit than he values the last item.

The concept of marginalism — closely tied to the concept of taste and preferences — can be relatively difficult to explain. It does, however, merit the time to study and understand because it plays such an important role in the price discovery process in markets.

Discussion

The manager of a hardware store decides to maximize his profit on hammers by offering them to buyers based on his assumptions about what buyers would be willing to pay, even though the hammers were all the same. He assumed that carpenters and rich people would be willing to pay the most. He assumed another group of people would not pay the high prices because they would use them only occasionally, but they would not want to seem cheap. At the low end, he would offer hammers to penny-pinchers and one-time users.

At the end of the month, while taking inventory, he discovered that none of the mid- and high-priced hammers had been purchased. The lowest-priced hammers were nearly gone.

He had just learned a lesson in marginalism. When buyers are offered the same product at different price points, regardless of their ability to pay, they will always choose the lowest price. Principal of marginalism plays a major role in setting market prices.

Marginalism also plays an important role in countering the argument that “greedy businesspeople” build their businesses on the backs of the poor.

Conclusion

As I will discuss in another article, marginalism plays an important role in explaining why businesses are more likely to lower prices than to raise them. Stated simply, far more people want a product at a lower price than at a higher price.