Diamond-water

Paradox
Fuzzy concept
Objectives Water Diamonds

Value in Use Very high Low

Value in Exchange Very low Very high

Total utility
TU = U1 + U2 + U3 + U4 Marginal utility
TUn = U1 + U2 + U3 + ………. Un MU = TUn – Tun – 1
TU = TUx + TUy + TUz + …….. + TUn

Scarcity attributes higher exchange value

 The Diamond-Water Paradox also known as (paradox of
value) is apparent contradiction
 Although water is on the whole more useful, in terms of
survival than diamonds, diamonds command a higher price
in the market.
 This paradox was proposed by economists in the 17th
and 18th century as a means understanding the role utility
plays in the demand price of a good by differentiating
between total utility and marginal utility.
 This concept was advocated by Adam Smith in his
publication An Enquiry into the Nature and Causes of
the Wealth of Nation in 1776
 He discusses the concept of value in use and value in
exchange – fuzzy concept Relatively exchange value will
be difference between them.
Value in Use – the things which have the greatest value in
use have frequently little or zero value in exchange -Water
Value in exchange – on the contrary The things which
have the greatest value in exchange have frequently little or
zero value in use – Diamond
Nothing is more useful than water, but it will purchase
scarce anything, scare anything can be had in exchange
for it.
Water is the most essential and precious resources
for human being as well as other lives beings such as
plants and animals etc. All living things cannot
survival without the water
We are using water for drinking, washing, cleaning,
bathing and making of food + various economic
activities such as agriculture and industries etc
Nothing is more useful than water, but it will
purchase scarce anything can be had in exchange for
it.
A diamond on the contrary, has scarce and highest
value in exchange when compare to other goods but
no useful from the society point of view.
 Diamond & Water paradox – perplexing observation
 Price – Even though water is obviously important to human
activity (life cannot be exist without water). The price of
water is relatively low.
 Alternatively, diamonds are clearly much less important to
human existence, but the price of diamonds is substantially
higher.
 Utility - the utility obtained from water is absolutely great,
while the utility obtained from diamonds is substantially
very less.
 However, because it is so plentiful, the marginal utility of water is
relatively low. An extra ounce of water provides very little
additional satisfaction.

Water – Diamond Paradox

Objectives Water Diamonds

Value in Use Very high Low/very low

Value in Exchange Very low/zero Very high

The key question is why diamond so
much expensive than water?
 Total Utility - Total utility refers to the sum
total of satisfaction which a consumer receives by
consuming various units of the same commodity.
 Total utility is the overall satisfaction of wants and
needs obtained from consuming a good
 Marginal Utility - Marginal utility is the
addition made to total utility by having an
additional unit of the commodity.
MU = TUn – Tun - 1
 Marginal utility can be defined as the change in the
total utility resulting from a one-unit change in the
consumption of a commodity per unit of time.
TU = U1 + U2 + U3 + U4…..
 If he consumes n units, the total
utility (TU) from n units can be
expressed as
TUn = U1 + U2 + U3 + ………. Un
 In case the number of commodities
consumed and their units are greater
than one, then
TU = TUx + TUy + TUz + …….. + TUn
 Where subscripts x, y, z and n denote
commodities
∆
 Water provides humans with an enormous amount of total utility.
Water satisfies A LOT of wants and needs for A LOT of people.

 Water provides a high level of total utility because it is plentiful of

water, water is everywhere.

 However, because it is so plentiful, the marginal utility of water is

relatively low. An extra ounce of water provides very little
additional satisfaction.
 Incontrast, the total utility generated by
diamonds is relatively limited. Diamonds do not
provide much overall satisfaction of wants and needs
compared to water.
 If human-being spend entire life - to get a piece
of diamond – not possible
Diamonds have very little total utility because they
are not nearly as plentiful as water.
However, because of less plentiful (shortage) the
marginal utility of diamonds is relatively high. The
extra unit of diamonds provides a great deal of extra
satisfaction.
 The law of diminishing marginal utility
 The key to the marginal utility differences the water and
diamonds is the law of diminishing marginal utility.
 Water is plentiful, marginal utility, is very low. The law
of diminishing marginal utility works its magic on
water, driving marginal utility down – very low level –
even it zero sometimes.
 However, because diamonds are substantially less
plentiful, marginal utility is much higher.
 The law of diminishing marginal utility is not active to the
same degree for diamonds.
 Water Diamonds

Abundance in Supply Shortage in supply

Total utility is large Total utility is less or

zero
Lower Marginal utility Higher Marginal utility

Low price High price

 Enter to Demand Price
 The critical determinants of price - Marginal utility, not total utility
 The price of water is relatively low because the marginal utility is
relatively low.
 The price of diamonds is relatively high because the marginal utility
is relatively high.
 In general, people are willing to pay a relatively higher demand
price for a good that generates relatively more satisfaction.
 Therefore, marginal utility is the prime determinant of demand
price.
  The paradox of value can be explained
with the help of a diagram. the marginal
utility curves for diamond (MUD) and water
(MUW) are shown as downward sloping
linear curves.
 In this figure, MUW is lying above MUD
curve, since consumer gets relatively
higher marginal utility from initial units of
water consumed by him due to its higher
use - value.
MUD
 Suppose, the quantity of diamond
available is OQD and that of water is OQw
Now, diamond will command a price of PD
Diagrammatically presentation QD with total utility equal to OAPD QD.
 Water will command a price of PwQw with total
utility equal to OBPwQw.
 Hence, the consumer would be willing and able to
pay for diamond is high, but, it has lower total utility
vis-a-vis water.
 On the other hand, the willingness to pay price is
very low for water, but greater total utility.
 Hence, price reflects marginal utility, while total
utility determines the use - value of the commodity.
 How to Solve the Paradox Problem
 The apparent contraction between price and utility is
cleared up by distinguishing between marginal utility and
total utility, and with the understanding that marginal
utility, not total utility is the key to determining price.
 Moreover, this paradox can be turned on its head by
considering what might happen should the relative
abundance of water and diamonds change.
1. If water were as limited as diamonds, then the
marginal utility and price of water would be higher
as diamonds
2. If water and diamonds were equally available the
price of water would likely to be several time higher
than price of diamonds.
3. If diamonds were as plentiful as water, then the
marginal utility and price would be lower than water.
4. If water and diamonds were equally abundant in
supply, then the price of diamonds could be a
fraction.