Notes on the Paradox of Value (diamond–water paradox)

Here we try to understand the contradiction that, although water is more useful and important for survival, it commands less value than diamond.

Labour theory of value

Adam Smith explains the rules which men observe when exchanging good for money or for other goods.

The rules determine the exchangeable value of goods.

The key word here is Value as it has two different meanings.

  • utility of a particular object (value in use)
  • purchasing power of an object towards other goods (value in exchange)

The things which have the greatest value in use usually has no or little value in exchange, on the contrary those which have the greatest value in exchange has little or no value in use

This can be observed in water even though it has a great value in use (survival) it can hardly purchase anything, on the contrary diamond has hardly any value in use but it can be easily exchanged for any other good

Further more he explains

The real price of anything, what everything really costs to the man who wants to acquire it, is the toil and trouble of acquiring it.

Marginalism

The theory of marginal utility (Subjective theory of value) say that the price at which an object is traded is determined neither by the amount of effort (labour) exerted to produce it nor by its usefulness as a whole. Rather is derived by its most important use to a person.

So a person will use a good to satisfy the highest priority need/want.

The value of water or diamond is not determined by its usefulness as whole but the usefulness of each unit of water or diamond.

Although water is important for the man survival, due to its large supply it has a low marginal utility. Each additional unit of water can be used to satisfy lower and lower priority needs/wants. Therefore any additional unit of water becomes less valuable as the supply of water increases. Diamond on the other hand, has much lower supply so the usefulness of additional unit of diamond far exceeds the usefulness of additional unit of water. Thus diamond are worth more to people.

A man dying of thirst would have greater marginal use of water till the point he is no longer dying.

References

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