The key question that arises is: Why are diamonds so much more expensive than water?

Total and Marginal

• Total Utility: This is the overall satisfaction of wants and needs obtained from consuming a good. That is, total utility is the accumulated amount of satisfaction, or the total value, generated by several units of a good.


• Marginal Utility: This is the extra satisfaction of wants and needs obtained from consuming one additional unit of good. That is, marginal utility is the incremental satisfaction generated by, and the value of, a single unit of a good.

In contrast, the total utility generated by diamonds is relatively limited. Diamonds do not provide much overall satisfaction of wants and needs, compared to water. Many humans spend their entire lives without achieving ANY satisfaction from diamonds.

Diamonds have very little total utility because they are not nearly as plentiful as water. Most houses do not have hot and cold running diamonds. Most people do not drink eight glasses of diamonds a day, take showers in diamonds, or fill their Olympic-sized swimming pools with hundreds of gallons of diamonds. However, because they are less plentiful, the marginal utility of diamonds is relatively high. An extra ounce of diamonds provides a great deal of extra satisfaction.

The Law of Diminishing Marginal Utility

However, because diamonds are substantially less plentiful, marginal utility is much higher. The law of diminishing marginal utility is not active to the same degree for diamonds.

Enter Demand Price

In general, people are willing to pay a relatively higher demand price for a good that generates relatively more satisfaction. However, because goods are sold on an incremental basis--one unit at a time--the additional satisfaction generated by each unit--that is, marginal utility--is the prime determinant of demand price.

Going to a Graph

A Generic Demand Curve

Most importantly, marginal utility determines the demand price that buyers are willing and able to pay for the good. As marginal utility declines, so too does demand price.

Consider how the availability of diamonds and water might be reflected with this marginal utility curve.

• Diamonds: Because diamonds are limited in supply, people are likely to operate relatively high on the marginal utility curve, near the vertical axis. That is, the quantity consumed is relatively small. Click the [Diamonds] button to highlight this option.

  Because the quantity is low, the marginal utility is high. The high marginal utility corresponds with a relatively high demand price. The total utility of diamonds, however, is indicated by the yellow area beneath the marginal utility curve. Because the quantity is limited, the total utility area is relatively small.



• Water: Because water is abundant in supply, people are likely to operate relatively low on the marginal utility curve, near the horizontal axis. That is, the quantity consumed is relatively large. Click the [Water] button to highlight this option.

  Because the quantity is high, the marginal utility is low. The low marginal utility corresponds with a relatively low demand price. The total utility of water, however, is indicated by the yellow area beneath the marginal utility curve. Because the quantity is abundant, the total utility area is relatively large.

Paradox Solved

Moreover, this paradox can be turned on its head by considering what might happen should the relative abundance of water and diamonds change.

• If water were as limited as diamonds, then the marginal utility and thus price would also be quite high. In fact, if water and diamonds were equally limited in supply, the price of water would likely be several times the price of diamonds.


• If diamonds were as plentiful as water, then the marginal utility and price would also be quite low. If water and diamonds were equally abundant in supply, then the price of diamonds would likely be only a fraction of the price of water.