DEFINITION: The “paradox of value”—also known as the “water–diamond paradox”—is the counterintuitive fact that the most valuable goods for human life and well-being, such as water, often have little or no exchange or market value, while goods with very high exchange or market value, such as diamonds, often have little or no value for human life and well-being.
ETYMOLOGY: The word “paradox” derives from the Greek word paradoxos, meaning “contrary to opinion,” “unexpected,” “strange,” or “marvelous.” The word paradoxos, in turn, is composed of the prefix para-, meaning “beside” or “beyond,” and doxa, meaning “opinion.”
The word “value” derives, via Middle English, Middle French, and Vulgar Latin, from the classical Latin verb valeo, valēre—more specifically, fromthe feminine of the past participle, valuta—meaning “be strong,” “be vigorous,” or “prevail.” Thus, the root meaning of “value” was originally “strength, “vigor,” or “predominance.”
The “Father of Economics,” Adam Smith, attempted to resolve the paradox of value by distinguishing between two different kinds of value, which he styled “use value” and “exchange value.”
Here is how he expressed the matter in his 1776 classic, The Wealth of Nations:
What are the rules which men naturally observe in exchanging them [goods] for money or for one another, I shall now proceed to examine. These rules determine what may be called the relative or exchangeable value of goods. The word VALUE, it is to be observed, has two different meanings, and sometimes expresses the utility of some particular object, and sometimes the power of purchasing other goods which the possession of that object conveys. The one may be called “value in use”; the other, “value in exchange.” The things which have the greatest value in use have frequently little or no value in exchange; on the contrary, those which have the greatest value in exchange have frequently little or no value in use. Nothing is more useful than water: but it will purchase scarcely anything; scarcely anything can be had in exchange for it. 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.
Smith then attempted to explain “exchange value” in terms of what later became known as the labor theory of value, writing:
The real price of every thing, what every thing really costs to the man who wants to acquire it, is the toil and trouble of acquiring it.
In other words, in Smith’s view, diamonds are worth more than water in “exchange value” because of the labor involved in mining and cutting them.
However, this cannot be whole story, because one can easily imagine circumstances in which someone would readily exchange a handful of diamonds for a canteen full of water.
Those circumstances, however, would have to include an immediate environment in which water was scarce—such as being marooned in the desert. In such an environment, one might think of the transportation of water to that location as being labor-intensive. Therefore, it might seem that the labor theory of value was correct, after all.
But scarcity and the amount of labor required to produce a thing or bring it to a particular location are two different concepts.
It is true that the much greater scarcity of diamonds than water is at the root of the paradox of value. However, scarcity is only a necessary condition for the paradox, not a sufficient one.
To understand the full story, including the sufficient condition for the paradox to occur, one has also to take into account the subjective state of mind of the individual consumer.
For this, we must turn to the subjective theory of value.
According to this theory—pioneered in the second half of the nineteenth century by Carl Menger, William Stanley Jevons, and Léon Walras—the value of goods is largely, if not wholly, determined by the preferences of individual consumers.
To illustrate: No matter how much loving labor a writer puts into writing a novel, if no one else wants to read it, it has no market value.
Analogously, if a man is dying of thirst in the desert, diamonds have no value to him, no matter how much labor went into their mining and cutting.
Contrariwise, if a man lives next to a river or a freshwater lake, water will be so plentiful that he can simply take it for granted. Thus, while water continues to have great fundamental value to him—it remains necessary to his very existence—circumstances are such that he is not conscious of this value.
So, it is not the case—as Adam Smith supposed—that there are two kinds of value: “use value” and “exchange value.”
Rather, it is the case that, while the value of a thing is based on the subjective preference of the individual consumer, part of that subjective preference itself is constituted by the degree of scarcity or abundance of the thing.