Editing Marginalism (section)

== Application to price theory ==
{{more citations needed|section|date=October 2021}}
Marginalism and neoclassical economics typically explain price formation broadly through the interaction of [[supply and demand|curves or schedules of supply and demand]].  In any case buyers are modelled as pursuing typically lower quantities, and sellers offering typically higher quantities, as price is increased, with each being willing to trade until the marginal value of what they would trade-away exceeds that of the thing for which they would trade.

=== Demand ===
Demand curves are explained by marginalism in terms of marginal rates of substitution.

At any given price, a prospective buyer has some marginal rate of substitution of money for the good or service in question.  Given the "law" of diminishing marginal utility, or otherwise given convex indifference curves, the rates are such that the willingness to forgo money for the good or service decreases as the buyer would have ever more of the good or service and ever less money. Hence, any given buyer has a demand schedule that generally decreases in response to price (at least until quantity demanded reaches zero). The aggregate quantity demanded by all buyers is, at any given price, just the sum of the quantities demanded by individual buyers, so it too decreases as price increases.

=== Supply ===
Both neoclassical economics and thorough-going marginalism could be said to explain supply curves in terms of marginal cost; however, there are marked differences in conceptions of that cost.

Marginalists in the tradition of [[Alfred Marshall|Marshall]] and neoclassical economists tend to represent the supply curve for any producer as a curve of marginal pecuniary costs objectively determined by physical processes, with an upward slope determined by [[diminishing returns]].

A more thorough-going marginalism represents the supply curve as a ''complementary demand curve''&nbsp;–  where the demand is ''for'' money and the purchase is made ''with'' a good or service.<ref name="schumMarshScis">Schumpeter, Joseph Alois; ''History of Economic Analysis'' (1954) Pt IV Ch 6 §4.</ref> The shape of that curve is then determined by marginal rates of substitution of money for that good or service.

=== Markets ===
By confining themselves to limiting cases in which sellers or buyers are both "price takers"&nbsp;– so that demand functions ignore supply functions or ''vice versa''&nbsp;– Marshallian marginalists and neoclassical economists produced tractable models of [[Perfect competition|"pure" or "perfect" competition]] and of various forms of [[Imperfect competition|"imperfect" competition]], which models are usually captured by relatively simple graphs.  Other marginalists have sought to present what they thought of as more realistic explanations,<ref>Mund, Vernon Arthur; ''Monopoly: A History and Theory'' (1933).</ref><ref>[[Mises, Ludwig Heinrich Edler von]]; [http://library.mises.org/books/Ludwig%20von%20Mises/Nationalokonomie%20Theorie%20des%20Handelns%20und%20Wirtschaftens.pdf ''Nationalökonomie: Theorie des Handelns und Wirtschaftens''] (1940). (See also his [https://mises.org/books/humanaction.pdf ''Human Action''.])</ref> but this work has been relatively uninfluential on the mainstream of economic thought.

=== Paradox of water and diamonds ===
{{main|Paradox of value}}
The law of diminishing marginal utility is said to explain the paradox of water and diamonds, most commonly associated with [[Adam Smith]],<ref>Smith, Adam; ''An Inquiry into the Nature and Causes of the Wealth of Nations'' (1776) Chapter IV. "Of the Origin and Use of Money".</ref> although it was recognized by earlier thinkers.<ref>{{cite book|first = Scott|last = Gordon|year = 1991|title = History and Philosophy of Social Science: An Introduction|chapter = The Scottish Enlightenment of the eighteenth century|publisher = [[Routledge]]|isbn = 0-415-09670-7}}</ref> Human beings cannot even survive without water, whereas diamonds, in Smith's day, were ornamentation or engraving bits. Yet water had a very small price, and diamonds a very large price. Marginalists explained that it is the ''marginal'' usefulness of any given quantity that matters, rather than the usefulness of a ''class'' or of a ''totality''.  For most people, water was sufficiently abundant that the loss or gain of a gallon would withdraw or add only some very minor use if any, whereas diamonds were in much more restricted supply, so that the loss or gain was much greater.

That is not to say that the price of any good or service is simply a function of the marginal utility that it has for any one individual nor for some ostensibly typical individual. Rather, individuals are willing to trade based upon the respective marginal utilities of the goods that they have or desire (with these marginal utilities being distinct for each potential trader), and prices thus develop constrained by these marginal utilities.{{Citation needed|date=October 2021}}