The Indicator from Planet Money - Why Do Diamonds Cost More Than Water?

The Diamond-Water Paradox: If we need water to survive and we don't need diamonds, why are diamonds expensive and water cheap?

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NPR

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Pretty Priscilla. It is Friday. You know what that means time for another one of our summer Friday economics lessons episode. We look at an economic Paradox. Dad speaking to wish there'd been a lot of paradox ish things happening lately like why home sales are setting records, even though unemployment is the highest been since the Great Depression that's paradoxical shift and dusted. Let's not even get started on the stock market, but maybe the very first economic Paradox ever tackled in an economic Seaway was by Adam Smith. One of the fathers of the field. It is called the diamond-water Paradox. This is the indicator from Planet Money. I'm Stacey Vanek Smith, and I'm part, of course, you know the show Diamond Water Paradox is episode first aired in July of 2018.

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Like a diamond. Cardiff. I like to think you're going there economics lesson in the story is forever. I went there and I did not apologizing which comes from NPR sponsor Microsoft. The world has changed and Microsoft teams is there to help us stay connected teams is the safe and secure way to chat meet call and collaborate to learn more visit microsoft.com teams. I am from the West I'm from Idaho. And in the west we are obsessed with water and a group with this kind of innate defensiveness around water. Somehow. I always had this feeling that Californians like evil Californians were coming after our water. I think the both I and our listeners are delighted to discover this kind of emotional water-based insecurity on your part for those crops.

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Songs from aquifers and rivers and streams. It's not come from rain. And so during droughts. Some Farmers would have their water shut off in the middle of a growing season and they would lose their whole crop. So water is a big deal is very emotional and that is probably why I've always been fascinated by this fundamental question economics called the diamond-water Paradox. And in fact, this Paradox is one of the first economic conundrums. It was ever formally articulated by Adam Smith founder of economics and to better understand it we called up Linda you what would the great Economist do how 12 Williams Minds would solve today's biggest problem and one of them say the father of economics himself Adam Smith, you might recall believed in the power of the market the so-called invisible hand that guides our economic interactions every single day, and he thought that the

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Free market was really good at placing the right value on things the right price on things before Smith. There were a couple.

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The side of this elegant Theory and one of them was the diamond-water Paradox. Okay, the diamond-water Paradox. Here it is. We need water to survive. We absolutely do not need diamonds to survive. So why is it the diamonds are so expensive and water. So cheap. Why do we value diamonds so much more than we seem to Value water which we literally cannot live without and yes Diamond our price more highly implying that prices and value don't quite match and this is a real conundrum because when out of Smith put forward his theory about how we should leave it to the market is on the basis that the market can efficiently priced based on Supply and based on what we demand and implicitly within that it's also reflection of the value and an intersection really struggled with it the first

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Supply there's water literally falling out of the sky gushing down from mountain peaks. Just sitting in big open lakes. And then there's Diamond do not fall out of the sky there in Fortune deep underground grounded by Rock. So like they're hard to get too hard to get out of the ground and that especially applies back in the 1700 when Adam Smith was riding pink away that I just began to view it is that diamonds and more scarce than water and that could explain some of the Paradox of it just needs is not quite solve the diamond-water Paradox because water is not always abundant the minute you start to realize that actually in some places of the world that water is scarce in the supply that begins. Look what I got Diamond. So then you would expect a higher price but this wind up usually don't really get higher price. And even if the price of water does go up,

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It does not typically get into Diamond price territory when it says it another solution Adam Smith and other Economist have considered was it may be the value of diamonds vs. Water had to do with the amount of labor involved in getting them like maybe we value Things based on how hard it is. How much work we have to do to produce them, but that wasn't really quite there either. That one also wasn't watertight watertight. Sorry Cardiff just looking at Labor wouldn't explain the diamond-water Paradox because yes Diamond can be hard to mine but water can sometimes be hard to get his well, if you live in for instance a desert in for a hundred years Economist were wrestling with this question, but the Paradox it wasn't really fully explained until the neo-classicists emerged.

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Talking specifically about Alfred Marshall Alfred Marshall famous economist. He was at Cambridge and he was very much in the school of Adam Smith in the tradition of Adam Smith and the way that Marshall track the diamond-water Paradox would by recognizing that the way we value things is not totally fixed. It's not the absolute price of the absolute levels utility that matters. It's the marginal utility is it when you said a price or something like a diamond or barrel of oil or a gallon of water? You don't just price it according to how much you value it writ large by how much you value its very existence because in that case water with Trump diamonds every single time, I mean, you literally needed to stay alive instead the value of something is dictated at least in part, but the extent to which you want that thing will you need that thing in a given moment? Exactly. So okay Cardiff up say that I have all the water I own all the water and you need water. So the first gallon of water

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The value for that is going to be really high. I mean you needed to survive. You would probably pay me anything I ask to get that first gallon of water 7 gallon also very valuable. You can use it to brush your teeth and wash your dishes all kinds of uses. The one that XX gallon or the 50th gallon. How much would you pay me for those it's more than you can use and now it's just taking up space in your apartment. And you know the apartment that is that becomes a problem by the gallon. In fact, you might not want that water at all anymore. It is not valuable to you but say you won't pay me anything for it at all its value for you has now dropped to nothing right because like I started by using it for the thing that I vitally needed it for to stay alive to hydrate right then I started using it for some things that we're plugged jerries SI taking a shower brush my teeth or whatever and beyond that I start to get a diminishing amount of enjoyment from the added gallon of water. So yeah.

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The first gallon gonna pay you all the money the last gallon I pay you anything. I might just pass it up. Exactly. But now imagine that I am selling diamonds that is a different story guess so you can imagine you have one Diamond. Maybe you get another done then I'll to pair of diamond earrings and showered

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So the first time in I get awesome the 20th Diamond still awesome the 50th Diamond still actually kind of awesome. The value of diamonds has less of a relationship to how many diamonds I've already got so I'd probably pay so close to the same amount for the 50th time in is a word for the first in part because I would expect those diamonds to hold their value in that might be why I bought them in the first place so we can say that the marginal value of diamonds the extra value get for another diamond is higher than the marginal value of water exactly more diamonds more value more is more more water. Not necessarily more value more is relative Diamond Water Paradox solved. It is funny. That way we value sings It's it is it is confusing. It's good to know that also Adam Smith struggled with this.

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Can't be explained what it means to be an economist.

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Is episode of the indicator was produced by Nick Fountain our editor is Patty Hearst and the indicator is a production of NPR.
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