The Marginal Revolution and the Paradox of Value

The Marginal Utility refers to how much satisfaction we get from consuming an additional unit. Do not confuse this with total utility. An example: if we are thirsty and drink 3 glasses of water, the total utility is the satisfaction we feel from drinking the 3 glasses, and the marginal utility is the satisfaction that each glass gives us individually.

The Marginal Revolution and the Paradox of Value Centuries ago, there was a much-discussed paradox, especially among economists. It was the famous paradox of value. This paradox was originally stated by Adam Smith:

Basically, the question is to understand why diamonds are much more valuable than water, considering that water is an essential good for human life and diamonds are not.

The Marginal Revolution

Three economists managed to resolve this paradox: William Stanley Jevons (1835–1882) in his work ‘The Theory of Political Economy’ (1871), Carl Menger (1840–1921) in his work ‘Principles of Political Economy’ (1871), and Léon Walras (1834–1910) in ‘Elements of Pure Political Economy’ (1874). A curious fact is that they elaborated this theory differently, in different places, without working together and at similar times. But even with their differences in how they arrived at the conclusion, the conclusion was very similar. This event became known as the The Marginal Revolution.

Solving the paradox

First of all, let us remember that each person values goods differently. And when we consume the same goods over and over again, we value the first one more than the others. This happens because, as we consume, our need is being met, and when we consume something again, we now have a smaller need, therefore, we will have less satisfaction than the first time.

The importance of water in our lives is much greater than that of diamonds. Water serves us not only to drink, but it also has countless other uses. The diamond, on the other hand, has lesser utility, and it is generally used for aesthetic purposes such as jewelleries (80%-90% of all diamonds) and for industrial purposes (10%-20% of all diamonds), especially from the beginning of the 20^th century. But even though the diamond is useful, it is safe to say that water is more useful, since without water we would not even exist. However, despite the greater utility of water, diamonds are much more expensive, that is, people pay much more for a certain amount of diamond than for a certain amount of water.

It is important to note that the amount of water in the world is much greater than that of diamonds. So it tends to be much easier to find water. If the amount of water available was similar to the amount of diamond, there is no doubt that water would be much more valuable.

Having made this observation, let us now address the law of marginal utility. The law boils down to the following:

The Marginal Utility refers to how much satisfaction we get from consuming an additional unit. Do not confuse this with total utility. An example: if we are thirsty and drink 3 glasses of water, the total utility is the satisfaction we feel from drinking the 3 glasses, and the marginal utility is the satisfaction that each glass gives us individually.

Therefore, generally speaking, receiving a little extra water would not add much satisfaction to us, and losing a little water would not be a great loss. On the other hand, diamonds are extremely rare. This means that gaining one more while having little is seen as having great value, and losing one is a considerable loss. Thus, the correct way to interpret marginal utility is to compare the new units of any good with the quantity that one already has previously.

Diamonds have a much higher marginal utility than water, but if the supply of diamonds increased, its marginal utility would tend to decrease.

In summary: Diamond is more valuable than water because its marginal utility is greater than that of water.