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.