2. Just as the notion of final utility solved one of the most difficult problems in economics, namely, why water, for example, has less value than diamonds, it also helped to clear up another mystery that had perplexed many economists from the Physiocrats downward, namely, how exchange, which by definition implies the equivalence of the objects exchanged, can result in a gain for both parties. Here at last is the enigma solved. In an act of exchange attention must be focused not upon the total but upon the final utility. The equality in the case of both parties lies in the balance between the last portion that is acquired and the last portion that is given up.
Imagine two Congoese merchants, the one, A, having a heap of salt, and the other, B, a heap of rice, which they are anxious to exchange. As yet the rate of exchange is undetermined, but let them begin. A takes a handful of salt and passes it on to B, who does the same with the rice, and so the process goes on. A casts his eye upon the two heaps as they begin mounting up, and as the heap of rice keeps growing the utility of each new handful that is added keeps diminishing, because he will soon have enough to supply all his wants. It is otherwise with the salt, each successive handful assuming an increasing utility. Now, seeing that the utility of the one keeps increasing, while that of the other decreases, there must come a time when they will both be equal. At that point A will stop. The rate of exchange will be determined, and the prices fixed by the relative measures of the two heaps. At that moment the heap of rice acquired will not have for A a much greater utility than has the heap of salt with which he has parted.
But A is not the only individual concerned, and it is not at all probable that B will feel inclined to stop at the same moment as A; and if he had made up his mind to stop before A had been satisfied with the quantity of rice given him no exchange would have been possible. We must suppose, then, that each party to the exchange must be ready to go to some point beyond the limit which the other has fixed in petto. This point can only be arrived at by bargaining.[1112]
3. Another question that requires answering is this: How is it that there is only one price for goods of the same quality in the same market? Once it is clearly grasped that the utility spoken of is the utility of each separate unit for each separate individual it will be realised that there must be as many different utilities as there are units, for each of them satisfies a different need. But if this is the case, why does a person who is famishing not pay a much higher price for a loaf than a wealthy person who has very little need for it? or, why do I not pay more when I am hungry than when I am not? The reason is that it would be absurd to imagine that goods which are nearly identical and even interchangeable should have different exchange values on the same market and especially for the same person. This law of indifference,[1113] as it is called, is derived from another law to which the Psychological school rightly attaches great importance, and which constitutes one of its most precious contributions to the study of economics, namely, the law of substitution. This law implies that whenever one commodity can be exchanged for another for the purpose of satisfying the same need, the commodity replaced cannot be much more valuable than the commodity replacing it.[1114]
For what is substitution but mutual exchange? And exchange implies equality, so that if there is a series of interchangeable goods none of them can be of greater value than any of the rest.
Consequently, if an individual has at his disposal 100 glasses of water, which is easily available everywhere except in the Sahara, perhaps, no one of these glasses, not even that one for which he would be willing to give its weight in gold were he very thirsty and that the only glassful available, will have a greater value than has the hundredth, which is worth exactly nothing. The hundredth is always there ready to be substituted for any of the others.
But the best way of getting a clear idea of final utility is not to consider the value of the object A, but of the object B, which can replace it. It becomes evident, then, that if I am about to lose some object, A, which I value a good deal but which can be perfectly replaced by another object, B, that object A cannot be much more valuable than B; and if I had the further choice of replacing it by C, C being less valuable than B, then A itself cannot be much more valuable than C.[1115]
We arrive, then, at this conclusion: The value of wealth of every kind is determined by the value of its least useful portion—that is, by the least satisfaction which any one portion of it can give.
Hitherto we have been concerned with the notion of final utility as applied to the problems of value and exchange, but has it the same effect when applied to problems of production, distribution, or consumption? The Hedonists have no doubt as to the answer, for what are production, distribution, and consumption but modifications of exchange?