Why are Diamonds More Expensive than Water?

A post by a particular B. Venkatesh entitled "The diamond-water paradox" (http://www. blonnet. com) is actually a fascinating short article on the nature of shortage as a main theme in any discussion on economics. The diamond-water paradox, which presumes the classic concern of why diamonds are more costly than water thinking about that the latter is better than the former, in fact, is a classic problem typically presented to trainees of economics. The problem is rather tricky but essential sufficient to warrant a severe discussion among the students of economics.

The short article is a great initial material for going over the TCO1, which discusses the basic economic problem of shortage, consisting of the contrast and contrast in ways capitalism and socialism offers with the three basic economic questions of what to produce, how to produce, and for whom to produce. The short article's central thesis on the utility and deficiency concern was presumed through a hypothetical circumstance. Suppose a person is in the middle of a desert, and passing away of thirst, what would this individual choose if he is offered diamonds or a bottle of water.

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Naturally in this situation, quenching his thirst would be even more important for the thirsty individual than the most costly piece of diamond worldwide. And in this specific scenario, water would be more beneficial than the diamonds, which in economics refers to the energy of water being higher than that of diamonds. And suppose, the article further competed, the same person after satiating his thirst was again offered bottles of water, it is only natural that this time, the person's demand for water will reduce.

In economic theory, this would mean the minimal energy for water being decreased.

And this time, the diamonds will suddenly have their importance being more urgent, and is suddenly more expensive that water. The marginalist theory of value in this instance clarifies this phenomenon by explaining that the usefulness of water as a whole affects price, and not the usefulness of one unit of water (total utility) but as a whole or marginal utility. In other words, because water is in large supply, the marginal utility is low and therefore the price is proportionally low. Conversely, because diamonds are useful but scarcer, each small unit of diamond is more useful than say, a bottle of drinkig water.

The pain equivalent to the lost of one bottle of water, when he has a dozen for instance, is less intense when he lost a one diamond when he has only one. In this context, the marginal utility of water is lower than that of diamonds. This explain why diamonds are more expensive than water. Marginal utility Graph But the prices of commodities, be it diamonds or water, have also other origin: namely, the intervention or non-intervention of governments, depending on what particular economic system is in force. In a market or capitalist economy, resources are allocated by prices without government intervention.

It is the private sector, through the private companies, that decides the type, (the what) quality, (the how) of commodity for a particular target consumer (the whom). An increase in the price of one commodity will encourage capitalists or producers to switch resources into that specific commodity or service, while in the long run, the consumers will chose the commodity with lower price, tempering the producer’s tendency to raise the price of their products. Of course, people with higher incomes are able to buy more goods and services than those with lower salaries.

In a socialist or command economy for instance, the government owns most resources and decides on the type and quantity of commodities to be made. It is also the government that sets output targets of particular products, affecting, in the process, even the prices of commodities. References http://www. blonnet. com/iw/2003/01/05/stories/2003010500241300. htm Bohm-Bawerk, Eugen von (1891). “Book III, Chapter IV: The Marginal Utility”, The Positive Theory of Capital. “A colonial farmer, whose log but stands by itself in the primeval forest, far away from the busy haunts of men, has just harvested five sacks of corn... ”