The Paradox of Value

The classical economists were unable to explain why diamond which is less useful commands a high price in the market but water which is very essential for human life is available at a low price. This is a paradox of value because higher price generally indicates higher utility of the good and lower price indicates lower utility. Thus, the diamond-water paradox prevented the classical economists to explain the price of goods in reference to the utility of these goods.

With the help of the marginal utility concept, the problem of paradox of value can be solved easily. The price of commodity is not determined by the total utility but by the marginal utility. According to the law of diminishing marginal utility. the marginal utility of a good declines as the stock of the good increases. In real life the marginal utility of diamond is higher than water. Water is available in plenty and diamond is a scarce commodity. The consumer has sufficient stock of water. Therefore the marginal utility of an additional glass of water is very low. But the marginal utility of all additional piece of diamond is very high. This is the reason why water is available at a low price whereas diamonds commands a high price in the market.

In a changed situation, the reverse would happen. For example if water is scarce as we find in case of a desert, then water would command a very high price than diamond. This is due to the fact that the marginal utility of water is very high in the desert.