Paradox of Value: Understand Why Water is Cheap and Diamonds are Expensive

Would you pay $5,000 for a glass of water? Probably not. But what about for a small diamond? Many would say yes.

Now, for the golden question (or diamond, in this case): which of the two is absolutely essential for your survival? The obvious answer is water. So, why does the item that keeps us alive cost pennies, while a shiny but useless stone for survival is worth a fortune?

Welcome to the Paradox of Value, also known as the diamond-water paradox. This is one of the most classic puzzles in economics, an enigma that reveals the surprising way our minds assign prices to things and how, often, logic seems to be set aside.

The Enigma That Puzzled Adam Smith

In the 18th century, the father of modern economics, Adam Smith, looked at the world and scratched his head. In his monumental work, "The Wealth of Nations," he observed this strange contradiction.

He divided the concept of value into two categories:

1. Value in Use: The actual, practical utility of an item. Water has immense value in use. Without it, we die. It's that simple.
2. Value in Exchange: What you can get in return for that item on the market. A diamond has a very high value in exchange. You can trade it for a lot of money, cars, or other goods.

The paradox was clear: why did things with a very high value in use (water) have a low value in exchange, and vice versa? Smith identified the problem perfectly, but the complete solution would only come a century later. He opened the door, but the key to unlocking the mystery was still missing.

The Missing Piece: The Marginal Utility Revolution

The major breakthrough came with a brilliant idea called marginal utility. Forget the complicated terms. The logic is incredibly simple, and you apply it every day without realizing it.

Marginal utility is the value you place on one additional unit of something.

Think of it this way: if you're lost in the desert, dying of thirst, the first glass of water is priceless. It's the most valuable item in the universe. The second glass is still incredible. The third, great. But what about the tenth glass? Or the hundredth? The value you assign to each additional glass decreases drastically. This is because water is abundant in our daily lives.

Now, think about diamonds. For most people, getting their first diamond is an event. The second one too. Because they are extremely rare (or, as we'll see, kept artificially rare), the "marginal utility" of having one more diamond almost never diminishes. Each additional unit still feels special and valuable.

The secret isn't in the total value of all the water on the planet versus all the diamonds. It's in the value of the next available unit. Since water is abundant, the next glass is worth little. Since diamonds are scarce, the next carat is worth a lot.

Unraveling Value: Myths vs. Facts

To clarify even further, let's break down some common myths about what defines the price of things.

MYTH	REALITY
"The price of something reflects its importance."	The price primarily reflects its scarcity and marginal utility (the value we place on the next unit), not its fundamental importance for life.
"Diamonds are expensive because they are naturally super rare."	Partly. But scarcity has historically been controlled by cartels, like De Beers, which limited supply to keep prices artificially high.
"The value of a product is objective and fixed."	Value is entirely subjective and contextual. An umbrella is worth $5 on a sunny day, but it could be worth $20 in the middle of a downpour for someone without protection.

Behind the Sparkle: Is Scarcity Real or Created?

The case of diamonds is a fascinating example of how exchange value can be manipulated. For decades, the De Beers company controlled about 85% of the global diamond market. They not only mined diamonds but also bought them from other mines to create a stockpile and release the stones into the market at a controlled pace.

Add to that one of the most brilliant marketing campaigns in history – "A Diamond Is Forever" – and you turn a carbon stone into an eternal symbol of love and status. They didn't sell a product; they sold an idea, anchored in carefully engineered scarcity.

What if water became extremely scarce tomorrow? If only a few companies controlled all access to drinking water, its exchange value would skyrocket. The paradox would instantly be inverted.

The Paradox in Your Shopping Cart (and Your Crypto Wallet)

Okay, the story is fascinating, but how does this affect you today? In every way.

• Smartphones and Fashionable Sneakers: Why do you pay $1,200 for the latest iPhone if the model from two years ago still works perfectly? Perceived marginal utility. The slightly better camera, the status of having the latest model, the new experience... all of this increases the exchange value in your mind, even if the use value (making calls, sending messages) is almost the same.

• NFTs and Cryptocurrencies: Bitcoin is the modern, digital example of the paradox. It has no physical "use value." You can't eat it or build a house with it. Its value is almost 100% derived from scarcity (there will only ever be 21 million units) and the collective belief in its exchange value. It's the 21st-century diamond.

• Your Own Value: Think about your career. Why does a highly specialized heart surgeon earn more than a cleaning professional, whose work is essential for public health? Scarcity of skill. There are far fewer people with the ability to perform a coronary bypass surgery than there are people with the ability to clean an office.

Understanding the Paradox of Value is like getting a pair of X-ray glasses to see the economy. You start to see the invisible forces of scarcity, desire, and context that dictate the prices of everything around you.