Login
Copyright

Diamond-Water Paradox in Economics: Definition & Examples

An error occurred trying to load this video.

Try refreshing the page, or contact customer support.

Coming up next: Diminishing Marginal Utility: Definition, Principle & Examples

You're on a roll. Keep up the good work!

Take Quiz Watch Next Lesson
 Replay
Your next lesson will play in 10 seconds
  • 0:01 Definition of…
  • 2:27 Examples
  • 4:21 Lesson Summary
Add to Add to Add to

Want to watch this again later?

Log in or sign up to add this lesson to a Custom Course.

Login or Sign up

Timeline
Autoplay
Autoplay
Create an account to start this course today
Try it free for 5 days!
Create An Account

Recommended Lessons and Courses for You

Lesson Transcript
Instructor: Aaron Hill

Aaron has worked in the financial industry for 14 years and has Accounting & Economics degree and masters in Business Administration. He is an accredited wealth manager.

Learn what the diamond-water paradox is. Find out why we are often willing to pay more for items we get very little use out of as compared to practical items we need for everyday life.

Definition of Diamond-Water Paradox

Have you ever purchased something and thought to yourself, 'It's crazy how much I'm paying for this!'? This might happen more frequently than you would like, based on the dozens of transactions you may make on a daily basis. Questioning some of your financial transactions may be best answered or explained through something known as the diamond-water paradox.

Getting enough water to sustain life typically has a low price, while a piece of diamond jewelry has a high price. Why does an economy put a much lower value on something vital to sustaining life compared to something that simply looks shiny and sparkles? This question is the diamond-water paradox, also known as paradox of value, and it was first presented by the economist Adam Smith in the 1700s.

In his works, Smith points out that practical things that we use every day often have little or no value in exchange. Things like cups, utensils, socks, and water are a few examples. On the other hand, things that often have the greatest value in the market have little or no practical use. An example may be an old piece of art or 1920s baseball card. Other than looking at it, there isn't much else we can do with the art or baseball card. So, why are things valued this way?

Understanding why the paradox exists can be helped by understanding the economic terms known as marginal utility and scarcity. Scarcity can be simply defined as how readily available a good, skill, or service is. Is there a lot of it compared to what people are demanding? Marginal utility is the additional satisfaction or gain someone gets from using or purchasing an additional unit of a particular good or service. People are willing to pay a higher price for goods with greater marginal utility.

So, let's go back to water and diamonds. There is plenty of water in most parts of the world (not scarce), which means that as consumers, we usually have a low marginal utility for water. In a typical situation, we aren't willing to pay a lot of money for one more drink of water. Diamonds, however, are scarce. Because they are harder to find and attain, our marginal utility (additional satisfaction), for adding a diamond to our collection is much higher than someone offering us one more drink of water. If one is dying of thirst, then this paradox might not make sense, and the marginal utility from another drink of water would be much higher than the additional satisfaction of owning a diamond. Let's look at a few examples.

Examples

Does paying $300-$400 dollars for an Xbox compared to $50 for a solid pair of shoes make sense? From a practical and survival standpoint, it certainly doesn't. In order to get around and enable our most basic form of transportation (walking), we need shoes to protect our feet. They are certainly more important and practical than an Xbox. The price difference comes back to the satisfaction, or marginal utility, we get from purchasing a pair of shoes compared to an Xbox. If you were in the middle of the jungle and trying to survive, you might pay more for those shoes, but until that happens, most of us will continue to pay more for our electronics!

Van Gogh, Picasso, and Monet paintings have sold for well over $50 million dollars! You can pick up a frying pan you can use every day to cook your food for less than $20 dollars. Marginal utility and scarcity can explain this crazy difference in value again, with a special emphasis on the scarcity of the products. There are millions of frying pans for sale. There may only be a few dozen original paintings from famous artists. The satisfaction someone gets from knowing he or she owns a rare piece of art is much higher than the satisfaction from owning another frying pan; therefore the person is willing to pay a much higher price for the art.

To unlock this lesson you must be a Study.com Member.
Create your account

Register for a free trial

Are you a student or a teacher?
I am a teacher

Unlock Your Education

See for yourself why 30 million people use Study.com

Become a Study.com member and start learning now.
Become a Member  Back

Earning College Credit

Did you know… We have over 95 college courses that prepare you to earn credit by exam that is accepted by over 2,000 colleges and universities. You can test out of the first two years of college and save thousands off your degree. Anyone can earn credit-by-exam regardless of age or education level.

To learn more, visit our Earning Credit Page

Transferring credit to the school of your choice

Not sure what college you want to attend yet? Study.com has thousands of articles about every imaginable degree, area of study and career path that can help you find the school that's right for you.

Create an account to start this course today
Try it free for 5 days!
Create An Account
Support