THE PARADOX OF VALUE.
Before heading for analyzing a paradoxical relation between diamond and water, let’s know how anything loses its value with its availability in abundance.
Anything available excessively loses its marginal value in the world. This has been discussed by renowned economists like Adam Smith, John Locke, and John Law etc.
Though the water is a life-giver and indispensable commodity for all, one would not be willing to pay a part of hard earned money for it. It cannot be compared with diamonds which are costly; a symbol of magnificence and people are willing to pay for it.
Water and diamond despite being found deep into the ground of earth deserve different values due only to theirs availability.
Water is available everywhere on earth. Be it lake, river, pond, well, rainy water or pumps, all of them are the good sources of water meeting the requirement without money.
Diamonds are available only in some places on earth. Extracting diamonds involves large expenditure, but their number happens to be scarce.
The paradox of value revolves round the “diamond water” dilemma.
The price of diamonds is much higher than that of water even though water offers more utility than diamonds.
This puzzle raises a question that “why is water which is more essential to human life cheaper than diamonds which is less or not essential?”
The resolution of this puzzle or paradox is based on the distinction between marginal utility and total utility.
We note that total utility of water that is its life giving benefit is indeed much higher than that of diamonds. However, price is directly related to marginal utility rather than to total utility. And indeed the optimal purchase rule [consumers equilibrium] states that price will tend to be equal to marginal utility [MU of X = Price of X].
This means that the higher the marginal utility, the higher the price and the lower the marginal utility, the less the price.
Water is extremely useful, it is vital for our existence, but available in plenty in many parts of the world ie its supply is greater than demand. It is a free good. Therefore it has little value – in – exchange or its price is low.
This means that consumers will correspondingly use large quantities of water. It is a free good and, therefore, its consumption can be continued till its MU = 0. Therefore, it fetches no price though its TU is high.
According to the law of diminishing marginal utility- the marginal utility of water to any household will be very low, hence the consumer is not willing to pay for water.
Diamonds are not essential for survival and are scarce in supply ie its supply is less than demand. They are economic goods. Diamonds though limited in utility have a high value – in – exchange or price is high.
Since diamonds are scarce, implying that less quantities of diamonds will be consumed by any household and it cannot be consumed till MU = 0. Therefore the marginal utility of diamonds is very high though TU is low as compared to water.and so consumers are willing to pay higher prices for diamond, than for water.
According to the law of diminishing marginal utility- the marginal utility of diamonds to any household will be very high, hence the consumer is willing to pay for diamonds.
The above analysis leads to a deduction that the scarcer a commodity is, the higher its marginal utility and its market price will be, regardless of the size of its total utility. In other words, scarcity raises price and marginal utility but not necessarily total utility.
This paradox can be turned on its head by considering what might happen should the relative abundance of water and diamonds change.
Each one of us, after finding all of our basic needs fulfilled, always forget to valuate the significance of water and diamond. Such allurement for diamond reveals a paradoxical relation between the diamond and water.
Eg1 People desire to own diamonds though they are expensive. However their reaction would be different if the water unexpectedly disappears from the earth, putting every one the verge of death. In such a situation if a person owning a well is blessed by God with plenty of water, all the diamond owners will beg for a glass of water exchanging all of their diamonds for the sake of their lives.
Eg 2 If water were as limited as diamonds, then the marginal utility and thus price would also be quite high. In fact, if water and diamonds were equally limited in supply, the price of water would likely be several times the price of diamonds.
Eg 3 If diamonds were as plentiful as water, then the marginal utility and price would also be quite low. If water and diamonds were equally abundant in supply, then the price of diamonds would likely be only a fraction of the price of water.