Diamond vs Water | A Debate of Commodity Prices

Posted By Robert On Sunday, August 24th, 2014 With 0 Comments

This is a subject that prior to discovering this article you would have given very little consideration to, water is cheap and Diamonds are expensive and that’s the way its been for our lifetimes and the way it will always be right?

So why then, do Diamonds demand a higher price than Water? After all, it is water, not Diamonds that are essential to life. Diamonds pose little use when you think if it, of course they are nice to look at and they put the Mrs in a good mood when you buy her one yet they serve very little function… so why are they so expensive compared to water!

Diamond vs Water

Here lies one of the most famous economical debates, the Diamond vs Water debate.

To help understand the Diamond vs Water debate we need to examine two Economical terms, “Total Utility” and ‘Marginal Utility’.

Utility is basically the satisfaction and/or usefulness you get from using a good or service. The utility of a massage would be very high where as the utility of a wet fart would be low (in most sane individuals).

So ‘Total Utility’ is the total of the amount of satisfaction/usefulness a consumer gets from consuming goods or service(s). So if we look at the total utility of water it must be quite high mustn’t it? It satisfies our thirst which is essential to sustain life, it functions as a cleansing tool which arguably can lower our chances of disease, we enjoy swimming in it and we can keep pet fish in it.

The total utility of water is very high, the total Utility of Diamonds is, well quite low! Other than decoration there is very little value that a diamond will give us. So using the theory of total utility – water should be valued more than diamonds, put simply, water is much more useful to us.

In the next step of the Diamond vs Water debate we need to move on to ‘Marginal Utility’ to see if this will help shed some light onto our diamond vs water dilemma. Marginal Utility is basically the satisfaction/usefulness we get when we consume more and more of a good. It is the measurement of satisfaction we get when we consume each additional unit of that product.

Let’s start with Diamonds this time, if you had one single Diamond, would you get much satisfaction from receiving another one, yes you probably would! What about another ten? Yes definitely, because Diamonds are a symbol of wealth and a great amount of goods can be exchanged for them. Well what about water, if you had one bucket of water and someone gave you another ten, would the satisfaction you got when you received your tenth bucket of water be consistent with the amount of satisfaction the first bucket gave you? Absolutely not. So we can say that water has a low marginal utility, because it loses its value to us the more units we receive but this is only because water is so plentiful.

If we lived in an environment where water was scarce then the Marginal Utility would be much different. Where as the tenth diamond we receive still has a high level of satisfaction so it’s marginal utility is actually quite high. There are many theories that Marginal Utility is the thing that we use when considering a commodity’s value.

This is an important factor for humans when deciding on the price of a commodity. We can relate to this with Chocolate, the more we consume of a product the smaller the increases in satisfaction we receive. If everybody agrees that each extra Chocolate consumed in one sitting adds less utility, then it makes sense that we will only demand extra chocolates if the price falls because we enjoy the last chocolate less than the first.

This theory does have exceptions however, like Alcohol, we cannot really state (or sometimes remember!) if the tenth unit we consume gave us less satisfaction than the first and quite often we enjoy Alcohol more with every unit we consume.

So if this was true then if pubs raised their prices slightly as the night went on, in theory people would pay the higher prices in exchange for the elevated level of utility. Which maybe helps justify in a way why drinks are dearer in night clubs than pubs.

It’s well known that scarcity of goods is what humans use to attribute value, which explains the price of Diamonds, Gold, platinum and other rare things like that. Water is also not seen as a precious thing in a well watered country, although nothing is more useful than water, hardly anything can be exchanged for it under normal circumstances. If a man with an ounce of Diamonds was dying from dehydration in a desert environment he would probably exchange every last Diamond for a few liters of water.

Although a diamond has very little value in terms of use, a very great quantity of other goods may be exchanged for it.  If water was as limited as diamonds, then the marginal utility and therefore the price would also be quite high. In fact if water and diamonds were equally limited in supply, the price of water would likely be several times the price of diamonds.

If diamonds were as plentiful as water, then the marginal utility and price would also be quite low. If water and diamonds were equally abundant in supply then the price of diamonds would likely be only a fraction of the price of water.

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