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 don't think this is a very good explanation, because it doesn't explain why people don't pay a lot more for their first gallon of water. People do value their first gallon of water per day highly, and would pay a lot for it if they couldn't buy it cheaper.
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.
For context, let me say that the book is packed full of great explanations. This part stood out for comment due to being an exception.
I think the actual reason water is cheap is high supply (relative to demand). (Or it would be if there was a free market for water. I don't know how the actual water market works. In real life there may be government controls. But the point here is abstract discussion of how markets work, not about the real US situation.)
In a free market for water, if someone tried to charge me a lot for my first gallon of water per day – say, 75% of the value to me, so we'd both benefit – the reason I wouldn't buy that water is because his competitor would sell it to me cheaper (and still make plenty of profit), because water is sufficiently plentiful and cheap to bring to market. Not because the marginal value of my 1000th gallon of water per day is only a tiny amount of money and I'd go without more water before paying a lot for that 1000th gallon.
I think a lot of other readers would have a similar objection, which is a problem even if for some reason Reisman's completely right here. At this point, I don't particularly suspect I have a substantial disagreement about economics with Reisman, I think he just did a bad job of explaining this topic in this small, early part of the book, but I'm expecting (or hoping for) some better explanations of this later.
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 much of his audience? 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 strongly disagree with this epistemology, which thinks you have some foundations and deduce the rest. See Karl Popper or my other writing for details.