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Tuesday, December 20, 2011

Paradox of value

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Both diamonds and water are scarce resources. A diamond is composed solely of carbon and its formation takes many billions of years. Exposed to intense heat and pressure hundreds of kilometers below sea level, the magical objects of desire are shaped by a powerful, natural process. Water is a daily necessity to each and every one of us. We need to drink water everyday, shower, washing and basically to survive.


Why are diamonds which have relatively little use to society; so costly, yet water which is fundamental to our way of life, so inexpensive?


Adam Smith (17-170) certainly believed that water is necessary for life (we will perish without it). By contrast, diamonds have little of such utility. They are only useful for adornment. It is possible to do without diamonds entirely yet diamonds cost so much more. Smith’s “paradox” as it has come to be known, highlights these two incongruous facts


1. If a product’s demand is largely dependant on its usefulness, then we would expect water; being the more useful of the two; to command a higher price.


Cheap Custom Essays on Paradox of value




. Diamonds are more costly.


The scarcity of diamonds will always ensure a high marginal value because an extra pound of diamonds has valuable uses that are not currently being met. Conversely, water is tremendously abundant and thus has a high total value and a low marginal value. A mere extra gallon of water is not particularly important.


For example, we assume that a person consumes units of water but no diamonds. The fourth unit of water would gives her only 10 additional units of utility. However, the first diamond would give her 150 units of utility (the marginal utility of diamonds increases as she consumes more diamonds). Therefore, she would be willing to spend 15 times as much for a 1 carat diamond as for a unit of water.


Conclusion


Consumers clearly get more total utility from water than diamonds. The last liter of water we drink or use in the shower gives us very little marginal utility. However, the last diamond still makes a big difference. People are willing to pay more for extra diamonds than for extra water because diamonds are rare and its value is greater than water. The total utility and marginal utility for diamonds will always increase. William Jevons (185-188) clearly states- “Cost of production determines supply, supply determines final degree of utility, final degree of utility determines value.” (Begg, Fischer and Dornbushch, 00, P. 71)


In view of this “paradox”, it has been maintained that it is not the usefulness of an object but scarcity that determines its price. Diamonds are expensive because they are rare. Water is inexpensive because it is widely found.


1. Jevons, William. ( 170 ) The Theory of Political Economy, Penguin, Harmondsworth


. Smith, Adam. ( 11 ) An Enquiry into the Nature and Causes of the Wealth of Nations, Oxford University Press, Oxford


. Beggs, David, and Fischer, Stanley and Dornbusch, Rudiger, Economics ( seventh edition ), McGraw- Hill Companies, Inc., 00


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