Why Do Diamonds Cost More Than Water?
N. P. R.. It is Friday. You know that means time for another one of our summer Friday economics lessons indicator summer school means yes. In this episode, we look at an economic paradox and speaking of webster definitely been a lot of paradox ish things happening lately like say home sales are setting records even though unemployment is the highest, it's been since the great. Depression that's paradox issues and the let's get started on the stock market. But maybe the very first economic paradox ever tackled in an economic way was by Adam Smith. One of the fathers of the field it is called the diamond water paradox. This is the indicator from planet money. I'm Stacey Vanik Smith I'm. CNN The show the diamond water paradox. This episode first aired in July of two thousand eighteen. What's like a diamond? Though Cardiff I liked things you're going their economics lesson in this story is forever. You went there I went there. Yeah. I did not apologizing. This message comes from NPR sponsor Microsoft the world has changed and Microsoft teams is there to help us stay connected teams is the safe and secure way to chat, meet, call and collaborate to learn more visit Microsoft? Dot. com slash teams. I. Am from the West I'm from Idaho and in the West, we are obsessed with water and a group with this kind of innate defensiveness around water. Somehow. I. Always had this feeling that Californian's like evil Californians were coming after our water I think the Both I and our listeners are delighted to discover this kind of emotional water-based insecurity on your part, and the reason for this is agriculture is really big idaho i. mean the potatoes and many other things A. and most of the water for those crops comes from aquifers and rivers and streams. It does not come from rain and so during droughts, some farmers would have their watershed off in the middle of growing season and they would lose their crop. So water is a big deal. It's very emotional. And that is probably why I've always been fascinated by the fundamental question economics called the diamond water paradox, and in fact, this paradox is one of the first economic conundrum. There was ever formally articulated by Adam Smith founder of economics into better understand it. We called up Lynn you. Hello, I'm Linda you. Honest at the author of what would the great in do? How twelve brilliant minds would solve today's biggest problems. And one of the brilliant minds is in Fact Adam Smith. Yes. Deep probably on, you might say the father of economics. Adam Smith you might recall believed in the power of the market the so called invisible hand that guides our economic interactions, every single day, and he thought that the free market was really good at placing the right value on things. The right price on things the for Smith there were a couple of thorns in the side of this elegant theory and one of them was the diamond water paradox. Okay. The diamond water paradox. Here it is. We need water to survive. We absolutely do not need diamonds to survive. So why is it? The diamonds are so expensive water. So cheap why do we value diamonds so much more than we seem to value water, which we literally cannot live without and yet diamonds are price more highly important thing that prices and vow you don't quite a and this is a real conundrum because when Adam Smith put forward his theory about how we should leave it to the market is on the basis that the market can efficiently price based on supply and based on what we demand and implicitly within that, it's also reflection of the value. and I. Really struggled with this, the first good old fashioned supply. There's water literally falling out of the sky gushing down from mountain peaks just sitting in big open lakes, and then there's diamonds which do not fall out of the sky there unfortunately deep underground or gently how Terrible. Surrounded by rock so hard to get too hard to get out of the ground and that especially applies back in the seventeen hundreds when Adam Smith was writing pink away on fifth began to view it is that diamonds are more scarce than water and could explain some of the paradox but not all of it Linda says, scarcity does not quite solve the diamond water paradox because water is not always abundant. The minute you start to realize that actually in some places of the world at water is scarce then the supply that begins look more like diamond. So then you would expect a higher price butts is Linda. Usually don't really get higher price and even if the price of water does go up, it does not typically get into diamond price territory witnesses that another solution, Adam, Smith and other communists have considered. Was it maybe the value of diamonds versus water had to do with the amount of labor involved in getting them like maybe we value things based on how hard it is how much work we have to do to produce them. But that wasn't really quite they're either that one also wasn't watertight. Watertight sorry guarded just looking at Labor wouldn't explain the Diamond Water Paradox because yes don can be hard to mine but water can sometimes be hard to get his. Well, if you live in for instance, a Desert Linda says Adam Smith died in seventeen ninety never having truly cracked the diamond water paradox and for one hundred years economists were wrestling with this question but the paradox it wasn't really fully explained until the neo-classicist emerge. So I'm talking specifically about Alfred Marshall Alfred. Marshall famous economist He. was at Cambridge and he was very much in the school of Adam. Smith in the tradition of Adam Smith and the way that Marshall cracked the diamond water paradox was by recognizing that the way we value things is not totally fixed. It's not the absolute price with the absolute level of utility that matters. It's the marginal utility. The idea is that when you said a price for something like a diamond or barrel of oil or a gallon of water, you don't just price it according to how. Much, you value it writ large how much you value its very existence because in that case, water would trump diamonds every single time I mean you literally needed to stay alive instead, the value of something is dictated at least in part by the extent to which you want that thing where you need that thing in a given moment. Exactly. So Okay Cardiff up say that I have all the water I own all the water and you need water. So the first gallon of water the value. For that is going to be really high. I mean you need it to survive. You would probably pay me anything I asked to get that I count of water the second gallon also very valuable. You could use it to brush her teeth or wash your dishes, all kinds of uses. But what about the Twentieth Gallon or the Fiftieth Gallon I mean how much would you pay me for those? It's more than you can use, and now it's just taking up space in your apartment and you know. Maybe, apartment that is that becomes a problem by the Fiftieth Gallon. In fact, you might not want that water at all anymore, it is not valuable to you, but so you won't pay me anything for it at all its value for you has now dropped to nothing right because like I started by using it for the thing that I vitally needed it for to stay alive to hydrate. Right then I started using it for some things that were luxuries I guess like taking a shower brushing, my teeth whatever. And beyond that I start to get a diminishing amount of information -ment from the added Gallon of water. So yeah. That first. Gallon. GonNa pay you all the money the last gallon. I might pay you anything and just pass it up exactly. But now imagine that I am selling diamonds. That is a different story. Yes. So you can imagine you get one diamond Maybe you get another dime in pair of diamond earrings. If you get another few diamonds, maybe make a bracelet all of a sudden Cardiff's all bloomed out. And showered. So the first time I get awesome the twentieth Diamond Still Awesome the, fiftieth diamond still actually kind of awesome The value of diamonds has less of a relationship to how many diamonds I've already got. So I'd probably pay close to the same amount for the fiftieth diamond is I. would for the first impart because I would expect those diamonds to hold their value in that might be why bought them in the first place? So we can say that the marginal value of diamonds, the extra value get another diamond is higher than the marginal value of water exactly more diamonds more value more is more more water not necessarily more value more is relative diamond water paradox solved. It is funny. The way we value things it it is. It is confusing. It's good to know that also Adam Smith struggled with this. Well he when economists struggle with something, they call it. Can't be. Not Confused they're struggling with the paradox. This is the nature of what it means to be in. This episode of the indicator was produced by Nick Fountain. Our editor is Paddy Hirsch and the indicator is production of NPR.