Question

Economists have been discussing for long the diamond-water paradox, i.e., why is the market value (price) of diamond more than the value of water even though the total utility of water is much more than the utility of diamond. How would you explain the diamond-water paradox?

Answer 1

The paradox can be explained in terms of the fact that the market value (price) of a good is related not to its total utility, but to its marginal utility. Water has low marginal utility as water is available in plenty and, hence, its total utility soon reaches the point of saturation (i.e., marginal utility becomes almost zero). Therefore, price of water is very low (almost zero). On the other hand, the total utility of diamond never reaches the point of saturation because of very limited availability of diamond. Therefore, marginal utility of diamond is very high, leading to a very high market price of diamond.