The concept of the value of goods was one of the most actively discussed topics by economists in the 18-19th century. In “A Study of the Nature and Causes of the Wealth of Nations,” published in 1776, Adam Smith voiced the question that would later become known as the diamond-water paradox. It sounded like this: “There is nothing more useful than water: but you can hardly buy anything with it… Diamond, on the contrary, has almost no use-value; but a very large number of other goods can often be obtained in exchange for it” (Smith & Stewart, 1963). This paper aims to explain the diamond-water paradox and discuss its solution.
The classical economists Adam Smith and Karl Marx considered a product’s value concerning how it satisfies a human need. The price was associated with the effort and labor expended to meet a specific demand. Besides, classical economists used the concepts of use-value and exchange-value, which determine the nature and exchange value of products. Later, in the 1860s–1870s, the British William Stanley Jevons, the Austrian Karl Menger, and the Swiss Marie-Esprit-Leon Walrus suggested that there could be no objective price for the goods. In particular, Karl Menger stated that there are no objective prices because prices result from subjective assessments, suggesting a price subjectivity theory (De Gree, 2018). Moreover, Menger, Jevons, and Walrus concluded that people deal with units of goods, and therefore diamonds and water should not be considered categories.
Further, economists formulated the concept of marginal utility to present a solution to the diamond-water paradox. According to this concept, the price of a product is determined by its marginal utility. Austrian economist Eugen von Boehm-Bawerk explained the concept of marginal utility, providing the example of a farmer who had five sacks of grain. The peasant used the first sack to bake bread in the amount that would allow him to survive. He used the second sack to bake enough bread to be healthy and able to work. The peasant used the third sack of grain to feed his domestic animals. He made whiskey from the grain in the fourth sack and fed the pigeons with the fifth.
According to the concept, if someone stole the fifth bag, the farmer would not cut all costs by one-fifth but would stop feeding the pigeons, since this is the least useful activity. Besides, the price of one sack of grain correlates with the pleasure that the peasant receives from the fact that he feeds the pigeons. However, if the farmer had four sacks of grain left, the value will be correlated with the satisfaction he receives from the whiskey. The first bag will have the highest marginal cost since it correlates with the farmer’s life value.
Then economists applied the concept of marginal utility to the diamond-water paradox and found the following solution. The price and value of water and diamonds are related to the circumstances in which a person is. The price and cost of water would be higher in the desert since water’s high use-value would be relevant here (Agarwal, 2016). But under normal circumstances, the price of a diamond would be higher due to the relevance of its high exchange-value. Despite the validity of Karl Menger’s concept of price subjectivity, economists continue to debate this idea’s validity. Besides, the views of Karl Marx and Adam Smith are still recognized as valid. For example, the cost of a diamond includes the costs associated with the extraction of diamonds. At the same time, water is cheaper since it is more affordable.
Thus, the diamond-water paradox was explained, and its solution was discussed. The diamond-water paradox lies in the fact that, despite the higher use-value of water, it costs less than diamonds. However, in non-standard conditions, for example, if a person were dying of thirst in the desert, the water cost would be higher since the diamond’s exchange-value would be depreciated. Remarkably, it took economists over a century to answer the diamond-water paradox presented by Adam Smith.
References
Agarwal, A. (2016). The paradox of value [Video file]. Web.
De Gree, A. (2018). The diamond-water paradox and the subjective theory of value. Web.
Smith, A., & Stewart, D. (1963). An inquiry into the nature and causes of the wealth of nations (Vol. 1). Homewood, Ill: Irwin.