Diamonds And Water

Value is a difficult concept to gauge. We regularly find ourselves at ballgames, theme parks, and movie theaters and we say openly “I would never pay those kinds of prices” and yet we still end up purchasing the $7 popcorn, $6 hotdog, and the $4 bottled water. The truth is that value is a completely subjective term, depending on the individual desires of people with differing value systems. Adam Smith who is known to many as the father of capitalism wrote in his famous work the Wealth of Nations about the paradox of diamonds and water. Water is very useful, in fact necessary for life or as economists explain, it has a high degree of utility. Although water is incredibly necessary it has a very low cost. Diamonds on the other hand are only used for adornment, are not necessary for life at all and yet they have a very high price. Why would this be? In the nineteenth century, Austrian economist such as, Eugen von Böhm-Bawerk developed the theories regarding the law of diminishing marginal utility to explain this paradox or rather clarified that it is a natural law, based on human action. He explains the law this way. A frontiersman has 5 sacks of grain and with the first sack he will make bread to survive. With the 2nd sack he will make bread to get strong so he can work. With the 3rd sack he will feed his livestock, with the 4th he will make whisky, and with the 5th sack he will feed the pigeons. If somebody steals one of the sacks of grain, the farmer does not reduce all his activities by one fifth to adjust, but rather he stops worrying about feeding the pigeons. If he loses two sacks, he’ll stop distilling whisky. It actually has nothing to do with the utility of the item, but rather the relative value of a unit of water vs a unit of diamonds. This explanation relies on the basic concepts of supply and demand. If you have something that is rare or in very limited supply it costs much more than something that is in abundant supply, regardless of its usefulness or importance. Everybody makes value judgments about what is most important and these decisions are always made on the margins. The 1st sack of grain is the most valuable to the farmer, because it is literally equal to the value of his life.



So you may be asking yourself, why the economics lesson? Most people don’t tend to think about the decisions they make in terms of value as these determinations are merely a gut feeling. Nobody likes to think of themselves like a commodity along the lines of a bushel of green beans or a barrel of oil. Anything we as humans produce is also subject to the laws of supply and demand including our labor. In a market economy nobody is really “given” a job but instead a trade takes place, just like anything that is purchased. An employer is trading money for labor and both parties value what they receive from each other greater than what they give up. If an employer is making the dollars for labor trade, he is going to pay for that labor according to its market value which is determined just like diamonds and water according to its abundance or scarcity. Two important lessons should be derived from this: First of all your usefulness and importance cannot be measured by the market value of your labor. Sure the major league pitcher is paid incredible sums of money to play a game. The question is; how many people are capable of throwing strikes at 95 miles per hour? Not many, which is why his labor comes at such a high price. That same major league pitcher may be cheating on his wife, abusing his children, and refusing to tip his waitress. His worth as a person cannot be judged by his salary. Conversely, just because a person does not earn a high salary does not mean they are of low value, but rather the skills of his labor are in great abundance (society needs people willing to do low paying tasks). If you want to earn more, offer something that is not commonly available or use your time of low pay to develop the skills that make your labor less common and thus more valuable. If you earn a wage that is not to your liking, understand this is a condition of market forces not a statement of your worth as a person. A better way to think of your employment is to envision yourself as an independent contractor with one full time client. An entrepreneur will endure many successes and failures on his way but he doesn't give up if he loses one client, he goes out and finds the next one.


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