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So, according to economists, marginal utility explains why the price of diamonds are higher than the price of water. But I don’t know why that’s necessarily the case. Yes, it’s true that the marginal diamond is worth more than the marginal bottle of water, but that doesn’t explain why the price of water is so low. It only makes sense if you assume the consumer has already had a ton of water. For instance, a person who has no water would be willing to pay a lot of money to get the 1st bottle, then a little less for the next bottle, and so on and so forth until they reach the last bottle, which they value at a very low price because they’ve already consumed every other unit. If I were a water supplier, why wouldn’t I price my bottles of water at the highest price someone is willing to pay?

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  • $\begingroup$ I don't think they can be compared. If water price goes too high there will be riots quick. People will overthrow the government. Diamonds are a frivolous. People only buy them with excess cash to show off. $\endgroup$ Jul 26, 2023 at 18:08

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So, according to economists, marginal utility explains why the price of diamonds are higher than the price of water.

This is not what economists claim. Diamond paradox is about explaining difference in value not prices. You can use the difference in values also as an argument for difference in prices but that goes step beyond. As mentioned in Encyclopedia Britannica:

... theory of value also supplies an answer to the so-called “diamond-water paradox,” which economist Adam Smith pondered but was unable to solve. Smith noted that, even though life cannot exist without water and can easily exist without diamonds, diamonds are, pound for pound, vastly more valuable than water. The marginal-utility theory of value resolves the paradox. Water in total is much more valuable than diamonds in total because the first few units of water are necessary for life itself. But, because water is plentiful and diamonds are scarce, the marginal value of a pound of diamonds exceeds the marginal value of a pound of water.


If I were a water supplier, why wouldn’t I price my bottles of water at the highest price someone is willing to pay?

  1. Because of competition. Price is not something a profit maximizing supplier can freely choose. Depending on level of competition price might be completely exogenous from the perspective of profit maximizing firm or endogenous if the level of competition is small (e.g. see Frank Microeconomics and Behavior pp 261-451). If price is exogenous then its determined by broader supply and demand over which individual firm has no control. If it is endogenous (from perspective of a firm) because there isn't much competition, firm can strategically adjust its prices and quantity sold to maximize profits, but it still can't just arbitrarily set any price.
  2. Even in absence of competition, in a corner case of a monopoly, even a purely profit maximizing monopoly would not choose price equal to willingness to buy of a consumer (barring special cases where parameters of problem are suitable for this). This is because generally speaking such pricing is not profit maximizing under regular market conditions and law of one price (see ibid).
  3. Such thing that you describe can only occur when at a market firm is able to do price discrimination of first degree. Price discrimination of first degree (as opposed to other types of price discrimination e.g. second or third degree) requires a firm to be monopolist that can observe the reservation price of individual consumers (ibid pp 393-394).

Empirically such situation generally does not exist in market for drinking water. First, in most places market for water is competitive. There are multiple brands and sources of water (tap/bottled water), there are also close substitutes (juice or other non-alcoholic beverages). In addition, water is homogenous fungible product such products typically can't be sold at the same time at different prices in presence of competition.

Second, every persons' reservation price is private information. A firm could at best use some visual clues to separate consumers into some large groups, but that is not sufficient for first degree price discrimination. So such situation would simply not normally occur in real life except for some special situations or locations where the conditions mentioned above would be present.

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  • $\begingroup$ Why would it not be profit-maximizing for a monopoly to price equal to what the consumer is willing to pay? $\endgroup$ Feb 3, 2023 at 20:14
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    $\begingroup$ because for homogenous goods provided by competitive firms typically law of one price applies. The price that one consumer is willing to pay would not necessarily maximize the overall profit $\endgroup$
    – 1muflon1
    Feb 3, 2023 at 20:27

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