Paradox of value

The paradox of value (also known as the diamond–water paradox) is the apparent contradiction that, although water is on the whole more useful, in terms of survival, than diamonds, diamonds command a higher price in the market. The philosopher Adam Smith is often considered to be the classic presenter of this paradox, although it had already appeared as early as Plato's Euthydemus.Nicolaus Copernicus,John Locke, John Law and others had previously tried to explain the disparity.

In a passage of Adam Smith's An Inquiry into the Nature and Causes of the Wealth of Nations, he discusses the concepts of value in use and value in exchange, and notices how they tend to differ:

Furthermore, he explained the value in exchange as being determined by labor:

Hence, Smith denied a necessary relationship between price and utility. Price on this view was related to a factor of production (namely, labor) and not to the point of view of the consumer. The best practical example of this is saffron (the most expensive spice), where much of its value derives from both the low yield from growing it and the disproportionate amount of labor required to extract it. Proponents of the labor theory of value saw that as the resolution of the paradox.

The labor theory of value has lost popularity in mainstream economics and has been replaced by the theory of marginal utility.

The theory of marginal utility, which is based on the subjective theory of value, says that the price at which an object trades in the market is determined neither by how much labor was exerted in its production, as in the labor theory of value, nor on how useful it is on the whole. Rather, its price is determined by its marginal utility. The marginal utility of a good is derived from its most important use to a person. So, if someone possesses a good, he will use it to satisfy some need or want. Which one? Naturally, the one that takes highest-priority. Eugen von Böhm-Bawerk illustrated this with the example of a farmer having five sacks of grain.

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