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Diamond-Water

Paradox

The apparently conflicting and perplexing


observation that water, which is more useful than
diamonds, has a lower price than diamonds.
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 those things
which have the greatest value in exchange have
frequently little or zero value in use Diamond
The paradox of value are also known as diamondwater paradox is the apparent contradiction.

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 could be dyeing if there is no
water.
We use water for drinking, washing, cleaning,
bathing and making of food as well as many
other activities such as agriculture and
industries.
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 any use, value


but a very great quantity of other goods may frequently
he had in exchange for it.
Diamond & Water paradox perplexing observation
Price Even though water is obviously important to
human activity (life cannot 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 obviously
very great, while the utility obtained from diamonds is
substantially 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
Value in Use
Value in Exchange

Water

Diamonds

Very high

Low/very low

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.

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.

In contrast, the total utility generated by


diamonds is relatively limited. Diamonds do
not provide much overall satisfaction of wants
and needs compared to water.
If humans spend entire their life to get a unit
of diamond cannot 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 difference water
and diamonds is the law of diminishing marginal
utility.
Because water is plentiful, marginal utility, is
quite 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
Marginal utility is
less or equal to zero
Low price

Total utility is less or


zero
Marginal utility is
high
High price

Enter to Demand Price


Marginal utility, not total utility is the critical
determinants of price.
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.

Diagrammatically presentation

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.
Suppose, the quantity of diamond available is OQ D
and that of water is OQw Now, diamond will
command a price of PD 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 Solved 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 thus price would also be
quite high.
2. If water and diamonds were equally available the
price of water would likely be several time higher
than price of diamonds.
3. If diamonds were as plentiful as water, then the
marginal utility and price would also be quite low.
4. If water and diamonds were equally abundant is
supply, then the price of diamonds would likely be
only a fraction of the price of water.