Water- Diamond Paradox
Water- Diamond Paradox
Water-Diamond Paradox is one of the
most famous puzzles in economic theory that is why diamonds are more expensive
than water. Water is essential for life as without its consumption one cannot
live or survive while diamonds, though attractive and beautiful, satisfy less
important human needs than water. Then, how it can be that less useful
commodity like diamonds is so expensive and a highly useful commodity as water
is very cheap in the market.
According to Adam Smith, value
has two different meanings. The one may be called “value in use”; the other,
“value in exchange.” The things which have the greatest value in use have
frequently little or no value in exchange; and, on the contrary, those which
have the greatest value in exchange have frequently little or no value in use.
Nothing is more useful than water: but it will purchase scarce anything; scarce
anything can be had in exchange for it. A diamond, on the contrary, has scarce
any value in use; but a very great quantity of other goods may frequently be
had in exchange for it.
Adam Smith emphasized the distinction
between value-in-use and value-in-exchange, and pointed out that value-in-use
of a commodity is much more than the value-in-exchange. Value-in-use of a
commodity signifies the utility or satisfaction which it provides to the
consumer, while value-in-exchange means the price paid by the consumer.
Adam Smith tried to explain why diamonds
are expensive since their supply is insufficient to meet demand, whereas water
is cheap because of its abundant supply.
He resolved the paradox in through the Labour Theory of
Value, essentially saying the real price
of everything, what everything really costs to the man who wants to acquire it,
is the toil and trouble of acquiring it. What is bought with money or with
goods is purchased by labour as much as what we acquire by the toil of our own
body. That money or those goods indeed save us this toil. The value of any commodity, therefore,
to the person who possesses it, and who means not to use or consume it himself,
but to exchange it for other commodities, is equal to the quantity of labour
which it enables him to purchase. Labour, therefore, is the real measure of the
exchangeable value of all commodities. He could not give satisfactory theory.
Modern economists are able to explain
the large price differential of water and diamond. According to them, it is determined
by its marginal utility. The marginal utility per litre of water
for the consumer is very low as the actual supply of water per period is
relatively very large. On the other hand, the marginal valuation or marginal utility
of diamonds is very high because the amount of diamond actually available is
very small. If, in fact, only few litres of water were available marginal utility
of water would have been much greater than that of diamonds. Thus, marginal utility
of a commodity reflects how much amount of money consumer is prepared to pay
for a commodity.
Market price of a commodity is
determined not by its total use-value but by its marginal valuation or marginal
utility which in turn depends on the actually available quantity. The total
use-value or total benefit which a consumer gets from a quantity of a commodity
equals the amount actually paid and the consumer surplus he obtains from it. In
case of water, market price as determined by its marginal benefit is low but
consumer surplus from it is very large. On the other hand, in case of diamond
due to their greater scarcity, marginal benefit and hence its price is large
but consumer surplus from it is very small. Thus, the concept of consumer’s
surplus shows that price should not be confused with use-value of a commodity
and this helps us to resolve the water-diamond paradox.
Dr. Swati Gupta
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