Menger derived the nature and origin of economic values through a methodological subjectivism – but not a metaphysical, moral, or psychological one. For Menger, economic values may be subjective, but they are not arbitrary: "Menger taught that there are objective laws of nature and that goods had objective properties that made them capable of fulfilling men's needs" (Younkins, p. 3).

          For Menger, the fundamental root of value is the need to sustain and enhance the valuer's biological life. Menger realized that the material world must be employed in a specific way to sustain human life and that "the value of goods is… nothing arbitrary, but always the necessary consequence of human knowledge that the maintenance of life, of well-being, or of some ever so insignificant part of them, depends upon control of a good or quantity of goods" (Menger, p. 120).

          Menger posited a sophisticated alternative to the conventional dichotomy that value is either wholly external to the mind or wholly created by it. Menger rejects both of these options and shows that value is formed subjectively on the basis of inescapable objective requirements: "While most accounts reduce value either to the mind or to some intrinsic property of things, Menger demonstrated that all social phenomena [were] composed of varying combinations of beliefs and entities, judgments and facts, mind and matter" (Zúñiga, p. 134).

          Many later economists have realized that calling Menger's theory of value "subjective" is a gross oversimplification; the theory can be better described in Richard C.B. Johnsson's words as "contextually individually objective" (Johnsson, p. 246). Individuals differ from one another and exist in different contexts; it is thus possible for one individual to value things differently from another and for both individuals to still value and pursue their lives to the fullest. Johnsson argues that this recognition is essential to marginal utility theory, for "[w]ithout this idea, Menger would not have been able to solve the old 'value paradox' of the classical economists" (Johnsson, p. 243).
 

The water-diamond paradox

          Having illustrated the essential characteristics of Menger's methodological individualism, methodological subjectivism, and contextually objective view of values, we can now examine how Menger resolved the water-diamond paradox. Because values are not intrinsic to goods but rather contextual, "[a] person assigns value to a good based on the end it enables him to achieve" (Younkins, p. 30). Hence, a person cannot value the world's entire existing stock of a given good; it makes no sense to talk about the value of water in general or of diamonds in general, because no acting individual ever chooses between all the world's water and all the world's diamonds. For the achievement of specific ends, an individual uses specific units of water, diamonds, and any other relevant good. An individual will value water and diamonds not as grand totalities, but rather on the margin – hence the term "marginal utility."

          Menger understood that the less scarce a given good is, the less value an additional unit will confer upon the individual obtaining it; this follows from the logically deducible law of diminishing marginal utility: "A given unit, quantity, or amount of a particular good will satisfy a person's most intense need or desire. After each unit consumed or used, a man's need or desire may be less intense. Each increment of that specific good available to him will be less valuable in his eyes." (Younkins, p. 16-17) If an individual has only one unit of a good, he will use it to fulfill what he considers the most important end that can be met with that good. If he obtains a second unit, he will necessarily devote it to his second most valued end; this continues indefinitely for however many goods an individual might possess.

          For example, one's first unit of water will be used to prevent one from dying of thirst. One's second unit might be used to nourish one's pet dog. The third unit might be allocated to watering one's plants. The fourth unit might be used in a decorative fountain outside one's house. If an accident spills the water one uses to sustain oneself, one will reallocate one's resources to serve one's most urgent priorities; the water originally intended for the fountain will instead be used to alleviate thirst.

          But in an advanced economy where water is abundant, one possesses so many units of it that the marginal utility of each additional unit would be relatively insignificant. In contrast, diamonds are extremely scarce relative to water; one is likely to have either no diamonds at all or only a few. Thus, each additional diamond will be put to one of the most highly-valued uses that can be found for diamonds. Of course, the most important use for a diamond – for example, using it in a ring or a highly precise diamond-edged saw – is far more valuable than the ten-thousandth most important use for a unit of water – hence the higher market price for a given diamond than for a given unit of water.

          Using this logic, Menger resolved the classical economists' paradox of value; he showed that value is an outlook of individuals toward individual units of goods and is determined in accordance with the law of diminishing marginal utility. The less of a given good an individual has, the more each additional unit of that good will benefit him. The market values of some economic goods in terms of other economic goods are thus determined by those goods' relative abundance in the possession of acting individuals. In a desert – where an individual is on the verge of dying from thirst – he might be willing to trade a million diamonds for a glass of water that would save his life.
 

Methodological subjectivism

          As a result of Menger's work, the field of economics was able to progress beyond the internal contradictions of the classical school's intrinsic labor theory of value. Through his methodological individualism, Menger showed the errors in the classical analysis of collectives as entities; he firmly grounded values in their source – valuing individuals.

          Through his methodological subjectivism, Menger refuted the notion that a product's value is determined by the labor invested in it; rather, value originates from the valuing subject's needs and preferences; "goods have no inherent or intrinsic value in themselves" (Younkins, p. 29). Through his contextually individually objective view of values, Menger grounded economic value in reality and showed that it is neither intrinsic nor arbitrary, but rather intimately connected to the objective advancement of the individual's life and flourishing.

          Menger applied these theoretical insights to solve the classical economists' water-diamond paradox – using the idea of valuation on the margin and the law of diminishing marginal utility to provide a logically sound case for why certain goods fetch higher market prices than others. Menger's work inaugurated an entire new economic paradigm – the Austrian School of Economics. The cornerstones of economic theory he discovered have strongly influenced economic giants such as Eugen von Böhm-Bawerk, Ludwig von Mises, Friedrich Hayek, Murray Rothbard, and Israel Kirzner (Younkins, p. 2). Today, Menger's discoveries continue to fuel a wealth of economic progress and analysis.