Seatwork!

1. Thinking like an Economist: Economics in ACTION!
Why are diamonds expensive while water is cheap? After all, water is essential for
survival, whereas diamonds are a luxury good used mainly in jewelry. This presents a
paradox, or seeming contradiction; how can something as important as water have a
lower price than something unessential like diamonds?
This question, known as the diamond- water paradox, was posed by Adam Smith in his
book The Wealth of Nations, back in 1776. Smith did not provide a satisfactory answer,
but another English economist, William Stanley Jevons (1835– 1882), did. Jevons pointed
out that people are willing to pay a very high price for water when they don’t have very
much. But because water is not very scarce— the supply is large relative to the
demand— people don’t have to pay a high price. The plentiful supply moves the
equilibrium point very far down along the market demand curve, driving down the
equilibrium price. Any seller who asks a high price— say P400— for a pint of water will
not be able to attract a buyer, even for a fancy bottle of Evian water. Diamonds, by
contrast, are found in only three U.S. states and a small number of countries, making the
available quantity relatively small. Some buyers are willing to pay several thousand
dollars for a diamond. They would pay even more for the first few pints of water needed
to stay alive, but they don’t have to because water is plentiful. For diamonds, buyers do
have to pay a high price, because the limited supply leaves the equilibrium point in the
diamond market higher up on the demand curve.
Did you get it? Answer the following:
1.) Why are some goods that nobody needs more expensive than some goods that
are essential to life?
2.) Explain the behavior of the marginal utility for water and diamond.
3.) Other than scarcity, what other indicators do you think the prices for water and
diamond are purely based on?
4.) Is diamond-water paradox something bizarre? Why?