In 2007 David Beckham made waves around the world by signing a five-year deal to move from Real Madrid in Spain to Major League soccer club LA Galaxy for a reported $250 million. It was the size of the deal that generated most interest. He may have been a good soccer star; he may also have been a massive marketing draw for both the soccer club and the league, which has struggled to compete with NFL, NBA and other American sports. But, really $250 million for one man?

Uneconomic though it may sound, the price paid seems in fact to have been a good one. The soccer club would not have paid it had it not expected to generate a healthy profit from the deal. Indirectly then, it is the public who consider Beckham, and footballers like him, worth that kind of price. They are willing to pay for Beckham-related products -- everything from soccer shirts with his name on them to the clothes and razors he promotes.

The Margin

Why is it that we place so much more value on one human being than another? Great athletes may be good at their sport, but why do they earn far more than even those whose roles are essential for our well-being -- teachers or doctors for example? The answer is to be found at what economists call the margin.

Some three hundred years ago, Adam Smith mentioned a not dissimilar paradox to the Beckham one in The Wealth of Nations. Why, he asked, was there such a difference in price between diamonds and water? Unlike water, diamonds are not essential for human existence; they are pieces of crystalline carbon -- albeit highly attractive ones. He reasoned that more work goes into making a diamond -- mining it, cutting it, polishing it and so on -- than providing water, which thus justifies the cost. Diamonds, moreover, are scarce, whereas water is plentiful for most of us in the Western world.

In the same way, there are only a small number of people who have David Beckham's ability to swerve a ball round a wall and score from free kicks. Scarcity pushes up the price. However, this is only half of the explanation. After all, there is just as scarce a supply of highly talented fencers in the world, and yet they are unlikely to earn even Beckham's weekly wage over many years.

The answer to the paradox, which was proposed by economists in the late 19th century (including Carl Menger of the Austrian School), is that the value of a given thing -- whether it is David Beckham, a diamond or a glass of water -- is subjective. It depends entirely on how people value that thing at a given moment. The point sounds simple but it turned out to be revolutionary. Previously, people assumed something had an inherent value; after the marginal revolution it became clear that things have value only insofar as people want them.

Marginal Utility

Let's go back to our glass of water. To someone who has endured days of thirst in a desert, that glass is invaluable; they would probably pay any amount of cash for it, even a diamond, if they had it. But the more glasses that are available to that person, the less they will be willing to pay. We need to determine the value not of all the water in the world but of each particular glass. And the satisfaction one would get from each extra serving of water is what economists would call the marginal utility of each glass. In this case, there is a diminishing marginal utility.

There are numerous examples of prices that have increased or decreased because the marginal utility of the commodity in question rose or fell. Oil prices were down at around only $20 a barrel in the early years of the 21st century, but only a few years later they vaulted up above $100 a barrel, at one point touching $140. Fears over supply, exacerbated by demand from fast-growing economies, meant that people were willing to pay higher prices. Then, only months later, the price plummeted back to below $40 a barrel again as the world economy suffered recession.

The idea of marginal utility blossomed under another of the great economists, Alfred Marshall (1842-1924), who propounded the idea that consumers take decisions based on marginal considerations. Previously, attention had focused more on supply than demand, but he argued that this one-sided approach was comparable to trying to cut a piece of paper (the paper being the price) with just one blade of a pair of scissors. Instead of considering something -- say, a glass of water -- to have a particular price, determined by the costs to the supplier of sourcing it and bottling it, Marshall emphasized that consumers' desires should also be considered. They will only buy a product, he argued, if the item: (1) looks attractive to them; (2) is affordable; and (3) is reasonably priced in comparison to other goods. Each of these considerations affects the marginal price, whether it be for a glass of water or a world-famous soccer player.

Thinking at the margin Marshall's emphasis was on the marginal; people only do something -- be it manufacturing light bulbs or cramming for an exam the following day -- as long as that extra work or light bulb is worthwhile. At a certain stage sleeping will become a more sensible plan than working through the early hours; likewise the revenue from producing a new bulb will become less than the cost of production. We all think at the margin -- it is the practical way to behave. Economies, therefore, advance in incremental steps rather than in giant leaps. The marginal revolution was what shed light on the true nature of economic evolution.

While all humans are by nature marginalists, it took Marshall to establish the idea of marginal utility as part of the economics bedrock. Now, such ideas inform business plans across the world. They are central to commerce.

Neither does the Beckham parable end there. Two years after the footballer's move, he was involved in a tug-of-war with Italian club AC Milan. The spat again underlined the importance of marginal utility considerations. The Italians considered a flat face-value fee would be enough for the player. But Tim Leiweke, chief executive of LA Galaxy, said: "What Milan don't understand is that behind this story there are fans that are renouncing their subscriptions and sponsors that want damages." This is a classic example of marginal thinking.