THE DIAMOND–WATER PARADOX | PARADOX OF VALUE

The water–diamond paradox is the contradiction that water, which is necessary for survival, is cheaper than diamond, which is not essential for human survival.

This was one mystery that Adam Smith, the father of modern economics, could not unravel.

He describes this problem in his 1776 book, "the wealth of nation" when he compared high-value diamond, which is not essential for human survival, to low-value water, which is essential for survival.

He concluded that "value in use" was unreasonably separated from "value in exchange".

In other words, " things with the greatest value in use sometimes have little value in exchange and things with little value in use sometimes have the greatest value in exchange". He could not explain this paradox.

Fews years after Adams smith presented this paradox, some economists deciphered the solution to this paradox. The answer to this paradox lies in the marginal utility theory.

The marginal utility theory states that the price of a commodity is determined by its marginal utility

Goods, as I told you before, have both total and marginal utility

Water is very useful in that we can not live without it. Therefore, it has a high total utility.

Diamond, on the other hand, is a luxury because we can live without it. Therefore, it has a relatively lower total utility than water.

Water is, however, relatively plentiful. Hence, people consume them at a low marginal utility.

Diamond is scarce. Therefore, we consumed them at a high marginal utility.

And since price is determined by marginal utility, the price of a diamond will be greater than water.

In other words, diamond has little use in value than water. However, diamond has greater use in exchange for water because of the marginal utility theory.
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