Did you ever wonder why the value of some goods is so much more than others. And did you consider the case of water and diamonds? Diamonds are mere accouterments and jewelry, yet they can sell for thousands of pounds. Water, essential for life, can be taken from a tap at a very low cost. Why do we seem to place a greater value on diamonds than water? This is called PARADOX OF VALUE.
The paradox of value (also known as the diamond-water paradox) is the contradiction that, although water is, on the whole, more useful, in terms of survival than diamonds, diamonds command a higher price in the market. The more classic and economic way of defining it can be like, “The observation that some goods which are more essential to human life can be cheaper than non-essential goods”.In this article, we go through things like the general and economic view of the idea, what is the real meaning, and the perspective we need to see it from so that we can resolve it.
A Scottish economist and philosopher, Adam Smith is often considered the classic presenter of this paradox. The paradox can be explained and resolved by the concept of marginal utility. The marginal utility of a good is derived from its most important use to a person. An Austrian economist, Eugen von Bohm-Bawerk in his 1889 book “The Positive Theory of Capital” offered an appealing demonstration of marginal utility. He explained this with the example of a farmer having five sacks of grain. The farmer may categorize those sacks to be used according to his desires the most urgent one being making bread so that he can eat and survive, the next making more food so that he can become strong and healthy to work and the remaining three sacks for other things with descending order of importance like feed his poultry and farm animals, to make whisky and finally feed the birds that amuse him. So, if he loses one of the sacks of grain he doesn’t reduce the use of grain by one-fifth for each purpose rather he would simply not feed the birds. Then the least important thing for him to do with the grain is to make his whiskey, and if loses four of the five sacks of grain his only purpose with that grain is food for him to survive, which means the last sack is worth his life. The price that the farmer would be ready to pay for the sack of grain would depend on how much he values feeding the birds, which is the least urgent and least essential of things rather than how much he values his life and survival, which is the most essential of all. He would be willing to pay the most price only when there is a limited supply of grain in the market due to some crisis.
Marginalists explain the diamond-water paradox by pointing out that it is not the general usefulness of the water or diamonds that determines the monetary value or price but it is the usefulness of each unit of water or diamond. In simple words, consider one unit of water to be the amount of water we use in a day. The marginal utility of water is fairly constant. Each day water gives a certain marginal utility (satisfaction). We need to keep buying and using water every day of our life. However, the marginal utility of diamonds is very different. Before getting married, a diamond ring brings a very high level of marginal utility, so we are willing to pay even 80-90k which is far more than the cost of a litre of water. But a week later, the marginal utility of another diamond would be very significantly lower. We don’t need to buy a diamond every week. If we did, it would lose its appeal of being a special one-off. If you were in a desert and dying of thirst, the marginal utility of a diamond would be practically zero, but the marginal utility of water would be very high. In this situation, the market price of water and diamonds would radically change.
Consider a person who bought a diamond for his marriage in 1970 for around 90k(in 2022 prices). It’s 52 years since then and there was not much of an occasion for him to buy a diamond ring after that. But he will be paying the water bill for every and every year for 52 years and will be spending money on things like drinks, etc with mostly water and some flavoring. A rough estimate amounts to a total of around 10 lakhs. Therefore, although the price of diamonds is higher than water. The total amount spent is very different. We buy diamonds maybe once or twice in a lifetime (apart from the super-rich), but we are buying water virtually every day. So it means that there is a huge difference between comparing the utility of a single unit and the utility of goods as a whole and it is the view of the temporary monetary value of a single unit that gives rise to this paradox. The ideal way to view it is through context, marginal utility, and logic of total expenditure
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