This section is from the "Elementary Principles of Economics" book, by Richard T. Ely and George Ray Wicker. Also available from Amazon: Elementary Principles Of Economics: Together With A Short Sketch Of Economic History
The Economic Order of Consumption. It follows from the law of diminishing utility that men in satisfying their wants consume commodities in a fairly regular order. So far as they consume things to the best advantage, their consumption is based upon a balancing of these two considerations, the utility of the goods, and the cost of procuring them. Therefore, in deciding what wants they will first satisfy, they will choose those commodities which promise the greatest surplus of utility over cost. At first thought the matter is indeed simple. To a starving man, the want for food or the marginal utility of food is so great that he devotes all his energies to satisfying that want. But when his hunger has been somewhat appeased, the unsatisfied want the marginal utility of some other good appears great by comparison, and he turns his energies in that direction. From these instances it might, indeed, appear that men always seek to get those things for which they have the greatest unsatisfied want; in other words, that they try to keep the marginal utilities of all commodities equal. But a moment's reflection will make it evident that the different degrees of sacrifice involved in getting the different commodities prevents any such adjustment of marginal utilities. My desire for an automobile may be vastly greater than my desire for a camera, but if I must sacrifice a whole year's income to get the automobile, I may prefer to purchase the camera. It is the relation between the unsatisfied want and the sacrifice required to satisfy the want that determines our choice.
To make this clearer let us take a detailed example. Suppose a boy with twenty-five cents of spending money standing before a booth at a fair, and bent on satisfying a want for goods there displayed. If peanuts are five cents a pint, it may be that his liking for them will be great enough to cause him to make a pint of them his first purchase. But he knows that a second pint will satisfy a want less keen than is satisfied by the first. We may imagine him, then, spending his second nickel for popcorn. In the same way, it may be, a first glass of lemonade will give him greater enjoyment than would a second pint of peanuts or a second bag of popcorn. It is possible that he has no strong desire for the other goods displayed, and that he can get greater satisfaction from a second pint of peanuts than from anything else that he could purchase, although they will afford less enjoyment than he will have from either the popcorn or the lemonade which he has bought. Again, it is quite possible that he will like a second glass of lemonade better than a third pint of peanuts or even a second bag of popcorn, because the action of the law of diminishing utility is more rapid in his consumption of popcorn than in his consumption of lemonade. Now the boy has purchased with his five nickels two pints of peanuts, one bag of popcorn, and two glasses of lemonade. The case is the same whether he buys them all at the same time or distributes his purchases throughout an afternoon. He makes his purchases according to his judgment as to their varying utility in such a way that he will receive the maximum enjoyment from his expenditure.
Illustration by Diagram. Let us illustrate this as before by a diagram, as on page 94;
In these figures the lines ox, o'x', o'x' represent amounts of the respective commodities which would reduce the marginal utility to zero; in other words, they represent amounts such that in no case would the boy care to consume them further. Let the parallelograms represent the satisfaction derived from the consumption of the different units. It will be noticed that the utility of the first unit is greatest in the first diagram and that it becomes less in each succeeding figure, but that the utility diminishes more slowly in Figure 3 than in Figure 2 Now let the cost of each unit be measured by the distance between ox, o'x', etc., and ab, a'b', etc., since this distance is the same in all cases, and in our illustration measures the five cents which each unit costs. In the diagrams it is evident that the first purchase will be made of the commodity repre--sented in Figure 1, since the surplus of satisfaction over cost i
Demand greatest in that case, this surplus being measured by the parallelogram az, which is larger than any of the corresponding parallelograms m, n, r, s. The parallelogram n, which represents the surplus of utility over cost of the first unit of the second commodity,in our illustration, popcorn, is greater than the parallelogram m, which represents the surplus of utility from a second unit of the first commodity, and is also greater than the parallelogram r, which represents the surplus utility from a first unit of the third commodity,in this case, lemonade. It will, therefore, represent the second purchase. In the same way r, being next in size, represents the third purchase; m, the fourth; and s, the fifth. Notice that while the first unit of the second commodity affords a surplus, the second does not. Again, notice Figure 4, which represents some commodity that the boy is not tempted to purchase with the stock of money in his possession.
It will be interesting and valuable practice for the student to vary these figures to represent different suppositions regarding consumption, and to carry the process one step farther by supposing the units of the commodity to be so small that the diminishing utility will be represented by a curved line instead of by the broken lines that form the top and part of the right side of the parallelograms in our illustration. Another variation might well be to have the costs vary from commodity to commodity.
We are now prepared for a formal statement regarding the economic order of consumption. So far as commodities are purchased and consumed rationally and economically, (1) choice is in every case determined by the amount of the surplus of utility over cost. It follows as a natural corollary that (2) each successive choice is dictated by the desire to have the surplus of utility of the commodity about to be consumed greater than the surplus which any other commodity of equal cost could yield.
How Economic Importance is Determined. Each consumer estimates the economic importance of any commodity, not upon the basis of its total utility, but upon the basis of its marginal utility. In other words, its importance is measured, not by the total amount of satisfaction that it can afford, but by the keenness of the desire or want that he would feel if deprived of any portion of the supply. If I were where I could not make any purchases of goods, nor add to my stock in any way for a considerable time, and if I had in addition to other goods fifty barrels of flour and only three pounds of sugar, I should evidently husband the sugar more carefully than the flour. In other words, I should calculate that with the existing stocks a pound of sugar had a greater economic importance for me than a pound of flour. If, however, instead of the greater quantity of flour, I had so little that ordinary consumption would use it up before the stock could be replenished, I should attach the greater economic importance to the flour instead of to the sugar. In each case my reason would be the same. In the first case sugar would have a greater marginal utility than flour, because diminution in its supply would leave me with an unsatisfied want keener than would follow from an equal diminution in the stock of flour. But in the second case the flour would have the greater marginal utility, since a decrease in its supply would involve actual hunger before the stock could be replenished.
It is instructive to compare the relation between the marginal utilities of two commodities with the relation between their total utilities. Thus, a pound of gold has a greater economic importance than a pound of iron; but the total amount of iron in existence has greater importance than the total amount of gold.