The Paradox of Value

Why is it that some items that have relatively little use to society, such as diamonds, are extremely expensive, whereas others that are vital, such as water, are inexpensive? Adam Smith and economists for a century after him struggled unsuccessfully to explain this Paradox of Value. Although Smith never unraveled the paradox of value, you can do it easily with a little help from the concept of consumers' surplus.

To see how this paradox is resolved, consider again the downward-sloping demand curve discussed in the last section. As an item grows more abundant, its total use value to consumers, which is the entire area under the demand curve, rises; but its price, or its marginal value to consumers, declines. Thus, if two items in the table below are available, the total value to consumers is $9.00 (or $5.00 for the first and $4.00 for the second), but the price or value in exchange is only $4.00. If six are available, total use value rises to $15.00, but exchange value (price) drops to $.50. Smith and his early followers missed this distinction between marginal and total. Thus, diamonds are scarce and have a high marginal value but a low total value. Another pound of diamonds has valuable uses that are not currently being met. Water is tremendously abundant and thus has a high total value and a low marginal value. Another gallon of water is not particularly important.

A Demand Curve
Amount People Are
Willing to Buy

If there is a consumers' surplus, should there not also be a producers' surplus?

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Copyright Robert Schenk