63
I
n 1769, Anne-Robert-Jacques
Turgot (p.65) noted that
despite its necessity, water
is not seen as a precious thing
in a well-watered country. Seven
years later Adam Smith (p.61)
took this idea further, noting that
although nothing is more useful
than water, hardly anything can
be exchanged for it. Although a
diamond has very little value in
terms of use, “a very great quantity
of other goods may frequently be
had in exchange for it.” In other
words, there is an apparent
contradiction between the prices
of certain commodities and their
importance to people.Marginal utility
This paradox can be explained
with the help of a concept known
as marginal utility: the amount of
pleasure gained from the last unit
of the commodity consumed. In
1889, the Austrian economist
Eugen von Böhm-Bawerk explained
it through the example of a farmer
with five bags of wheat. The
farmer’s use of the wheat rangesfrom important—feeding himself—
to trivial—feeding birds. If he loses
a bag of wheat, he will merely stop
feeding the birds. Even though the
farmer needs wheat to feed himself,
the price he is willing to pay to
replace the fifth bag of wheat is low,
because it only generates a small
amount of pleasure (feeding birds).
Water is abundant, but diamonds
are scarce. One extra diamond has
a high marginal utility and so
commands a much higher price
than an extra cup of water. ■THE AGE OF REASON
Diamonds are worth more than
water because each one is extremely
valuable no matter how many you have,
while water becomes less valuable, per
unit, as quantities increase.IN CONTEXT
FOCUS
Theories of value
KEY THINKER
Adam Smith (1723–90)
BEFORE
1691 English philosopher
John Locke connects a
commodity’s value to its utility
(the satisfaction it affords).
1737 Swiss mathematician
Daniel Bernoulli poses the
“St Petersburg Paradox,”
examining how players can
evaluate options involving
chance. The paradox is
resolved by applying the
concept of marginal utility.
AFTER
1889 Austrian economist
Eugen von Böhm-Bawerk
develops the subjective
theory of value (the value
of an object depends on a
person’s needs rather than
the object itself), using the
idea of marginal utilities.
WHY DO DIAMONDS
COST MORE THAN
WATER?
THE PARADOX OF VALUE
See also: The labor theory of value 106–07 ■ Utility and satisfaction 114–15 ■
Opportunity cost 133