Marginalism is a theory of economics that attempts to explain the discrepancy in the value of goods and services by reference to their secondary, or marginal, utility. The reason why the price of diamonds is higher than that of water, for example, owes to the greater additional satisfaction of the diamonds over the water. Thus, while the water has greater total utility, the diamond has greater marginal utility.
For issues of marginality, constraints are conceptualized as a border or margin. The location of the margin for any individual corresponds to his or her endowment, broadly conceived to include opportunities. This endowment is determined by many things including physical laws (which constrain how forms of energy and matter may be transformed), accidents of nature (which determine the presence of natural resources), and the outcomes of past decisions made both by others and by the individual.
In 20th century mainstream economics, the term "utility" has come to be formally defined as a quantification capturing preferences by assigning greater quantities to states, goods, services, or applications that are of higher priority. But marginalism and the concept of marginal utility predate the establishment of this convention within economics. The more general conception of utility is that of use or usefulness, and this conception is at the heart of marginalism; the term "marginal utility" arose from translation of the German "Grenznutzen", which literally means border use, referring directly to the marginal use, and the more general formulations of marginal utility do not treat quantification as an essential feature. On the other hand, none of the early marginalists insisted that utility were not quantified, some indeed treated quantification as an essential feature, and those who did not still used an assumption of quantification for expository purposes. In this context, it is not surprising to find many presentations that fail to recognize a more general approach.
At the highest level of generality, a marginal cost is a marginal opportunity cost. In most contexts, however, "marginal cost" will refer to marginal pecuniary cost – that is to say marginal cost measured by forgone money.
Marginalism and neoclassical economics typically explain price formation broadly through the interaction of 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.
Marginalists in the tradition of 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.
The first unambiguous published statement of any sort of theory of marginal utility was by Daniel Bernoulli, in "Specimen theoriae novae de mensura sortis". This paper appeared in 1738, but a draft had been written in 1731 or in 1732. In 1728, Gabriel Cramer produced fundamentally the same theory in a private letter. Each had sought to resolve the St. Petersburg paradox, and had concluded that the marginal desirability of money decreased as it was accumulated, more specifically such that the desirability of a sum were the natural logarithm (Bernoulli) or square root (Cramer) thereof. However, the more general implications of this hypothesis were not explicated, and the work fell into obscurity.
Although the Marginal Revolution flowed from the work of Jevons, Menger, and Walras, their work might have failed to enter the mainstream were it not for a second generation of economists. In England, the second generation were exemplified by Philip Wicksteed, by William Smart, and by Alfred Marshall; in Austria by Eugen Bohm von Bawerk and by Friedrich von Wieser; in Switzerland by Vilfredo Pareto; and in America by Herbert Joseph Davenport and by Frank A. Fetter.
