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Critical Thinking 1: The diamond-water paradox

In “An Inquiry into the Nature and Causes of the Wealth of Nations” published in 1776, Adam Smith wrote:

“Nothing is more useful than water: but it will purchase scarcely anything… A diamond, on the contrary, has scarcely any use-value; but a very great quantity of other goods may frequently be had in exchange for it”

Explain the diamond-water paradox and find out in the literature how economists have later solved this paradox.

Answer 1

The diamond water paradox explains how despite being the most useful thing on the planet, water is cheap in value or even sometimes freely available, while diamond on the other hand is highly expensive, despite its limited usage in jewelry.

This paradox was solved by understanding the fact that prices of these goods are influenced by their relative scarcity.

Since water is easily available and is not scarce, while diamonds are highly scarce and limited in numbers, it makes water being valued less while diamonds being highly expensive.

This explains that prices of goods are derived from their relative scarcity in the world economy.