Professional Documents
Culture Documents
Shubham Gupta
IIT2013180
Diamond-Water Paradox
The Diamond-Water Paradox, also known as the Paradox of Value, is a famous contradiction that has
been argued for long by Economists. Coined by Adam Smith, the paradox points out a rather strange
but usual anomaly that water, despite being life-essential, has a very low market value; whereas
diamond, having little usefulness in our daily lives, is very costly.
Concepts of Utility
To explain this paradox, Economists have taken the aid of concepts of Marginal Utility and Total
Utility. It is suggested that neither the supply, nor the demand alone determine the market value of
a commodity. Not even the Labour Theory of Value, viz., Commodities requiring high labour input
for production cost more, is capable of describing this price disparity.
Instead, it is said that Marginal Utility is the chief deciding factor of a products price. So it was
reasoned that Diamond, having a high Marginal Utility costs much more than water, that only has a
high Total Utility. This can be seen from the following curve:
Explanation
Eugen von Bohm-Bawerk tried to clarify this with the example of a peasant with five sacks of grain.
Suppose a farmer has 5 sacks of grains, each one of which is used in the following manner:
1. First sack satisfies the basic nutritional requirement of the farmer
2. Second sack is also consumed by the farmer, but only out of surplus in order to gain
additional nourishment to strengthen himself physically, so that he can do more laborious
tasks
pg. 1
Principles of Economics
Shubham Gupta
IIT2013180
Conclusion
So while the Total Utility of grains, and similarly of Water is very high, since it is life-supporting
commodity, its Marginal Utility is quite low. This is a direct consequence of the abundance of grains
as well as Water.
Contrary to this, the Total Utility of Diamonds is negligible but their Marginal Utility is very high. This
is supported by the fact that Diamonds are a rarity and a lot of effort goes into extraction and
polishing of a handful of them.
Another perspective to view this is that relative price is not governed by the total usefulness of
water or diamond but by the usefulness of each additional unit of these two. In this context, one can
easily see that each additional litre of water adds lesser value to the life of people because it is
already available in surplus so that its Marginal Utility remains low. Opposed to this, Diamonds are
so scarce that owning an extra gem doesnt impact its usefulness as a valuable possession.
Note
The concept of Marginal Utility employed in above discussion also applies to special and unique
scenarios. For instance, a thirst-gripped wanderer in a desert would happily trade-in a gemstone for
glass of water because at that moment, the Marginal Utility of a glass of water for him would be
greater than diamond. He might even exchange one or two more gems before switching back to
diamond-centric ideology!
pg. 2