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INTRODUCTION:

 

Per the  Oxford Dictionary Value is defined as:

1. The regard that something is held to deserve; the importance, worth, or usefulness of something.

2. The material or monetary worth of something [1].

The first definition of the term Value is more categorically aligned with a qualitative application of the term. The second definition is more of a reflection of a quantitative assessment of value through the assignment of monetary value. While qualitative and quantitive expression of the concept of value is to some degree separated, they are not mutually exclusive. The correlation between the two is actually quite salient. Almost always, when goods and services are qualitatively high in the value they come at a high price.

However, the question does resignation of how do we as a society assess the value of goods and services? An even more pertinent question being is this assessment ever erroneous?  It is severely difficult to ascertain if the commodities we value over other goods are done so in fallacy. Mainly because there is a certain amount of subjective always attached to assessing value. This aspect of the process of making attributions is epitomized by the idiom “One man’s trash is another man’s treasure” [2]. Exemplifying the fact that the validity of the indispensable nature of subjectivity in the process of judgment is solidified in conventional wisdom. Even though to many the subjectivity that encompasses judgment is so evident it is merely obtuse to even address it. Certainly, a truth about behavior and reasoning that goes unspoken and is seemingly innate.

The assessment of the qualitative value of one brand of sneakers over another being reflected by the monetary value seems like a trivial comparison. Neither one of the two goods in the comparison is crucial for our survival. It is apparent that the price difference and judgment of value between the two pairs of sneakers could be based on consumer preference. What if we were to make a comparison between a commodity that is essential to sustaining life and the other being a luxury product?  For example, the value of a fine Single malt Whisky in comparison to an antibiotic. Let’s say in theory the Whisky costs more than the antibiotic, is something askew here? Or better yet why is it that the luxury commodity of diamonds so vastly more costly or valuable than water?  Water a resource we cannot live without, under extreme circumstances death could result after several hours without it [3]. This very quandary is regarding the value of goods is manifested in Adam Smith’s dilemma of the Diamond Water Paradox.

The Diamond Water Paradox which was formulated by the moral philosopher of the Scottish Enlightenment Adam Smith. Smith brilliantly defended free-market capitalism in his premiere masterpiece  The Wealth of Nations (1776). Despite his contributions to economics and moral philosophy, he was never able to come to a resolution to this problem within his lifetime [4]. Over the years this economic puzzle has been renamed under the moniker of  Theory of Value. Posthumously, several other schools of thought presume to have the answer to Smith’s dilemma.  While the two economic perspectives are diametrically opposed, I will present and examine both perspectives.

 

DIAMOND WATER PARADOX:

While several schools of economic thought purport to have the resolution to Smith’s quandary,  his befuddlement isn’t so outlandish. The fact of water, a life-sustaining resource, costing less than the luxury good of diamonds is counterintuitive. It certainly is not capricious to grapple with this paradox considering the axioms presented above. When submerging yourself into this question you are confronted by oblique logic. It becomes evident that potentially our attribution of monetary value may be independent of the significance of the commodity. Clearly, a bottle of cognac can be sold at a higher retail price than a bag of spinach. However, the bag of spinach contains more nutrients than the bottle of cognac. The deeper you become entrenched in this logical puzzle, the more perplexing it becomes.

When assessing this paradox it might lead one to believe that we as a society are misprioritizing our goods.  The partner does appear to be those luxury goods and other nonessentials at times cost more than essentials. However, this isn’t always the case and becomes a much more convoluted inquiry when we veer off into this direction. However, we should engage in examing this inquiry because the Diamond-Water Paradox is still a contested problem to this day. It comes in the form of many manifestations. If we do not understand how market prices are assessed we will still continue to suffer much confusion.

In our modern world, we are still plagued by the same issue that Smith grappled with nearly three hundred years ago.  Commonly you will hear the sanctimoniously echoing sentiment of the fallacy of how a reality television star makes more money than first responders.  Another example is the significant and rapidly deepening gulf between the compensation between teachers and professional athletes [5]. Both examples are modern manifestations of the Diamond-Water Paradox. The sense of outrage and cognitive dissonance implied in both examples illustrates that even in modern times we are still struggling with this logical issue. Due to the lack of comprehension and critical analysis of the assessment of pricing such perceived injustices seem astonishingly jarring. The expression of such grievances provides little insight into this phenomenon nor does it provide any solutions.

Considering how easily applicable this paradox is to modern affairs it is a testament to its enduring nature. Smith was hardly contemplating the equity of compensation. Back in the 1700s highly consolidated and government bulwarked unions did not exist in the same capacity they do now. The real powerful government-supported unions did not come to fruition until the 1920s and 1930s in the United States [6]. Smith was examining this phenomenon of pricing in a slightly less complex world. However, he at least was postulating about the mechanisms of pricing. He purposed that a commodity was worth the amount of labor exerted to create or obtain goods or services  (page 28) [7].  Smith was also prudent enough to point out some of the fallacies inherent in his own view of value assessment.  As Smith asserts that when comparing goods produced by two different types of labor it is difficult to determine if they are equal  (page 29) [8]. Due to the number of varying contingencies and qualitative differences.

Beyond his interpretation of the production value of goods and services he also directly addresses the paradox in his Magnus Opus The Wealth of Nations.  Smith makes the distinction that there are two types of value appraisals for goods and services.  The first being “Value of Use” which is in direct reference to the utility of a commodity.  The second being the  ” Exchange Value” of a commodity or purchasing power.  His explanation indicating water having a significant amount of utility due to it being essential for survival.  Diamond having a  significant  “Exchange Value”  due to the number of goods you can exchange diamonds for (high purchasing power) (page 26) [9]. Unfortunately, Smith does not have a satisfactory rationale for why this discrepancy exists. Even in light of it boarding on the line of absurdity if taken from a linear interpretation.

 

THE AUSTRIAN SOLUTION:

The lack of alignment between “Value of Use” and “Exchange Value” requires an analysis of what is qualitatively different between these two variables. It would be innate to think that they are to some extent interconnected or even correlated. It is possible that even the two varieties of value appraisals are independent of one another. Despite how far off course we can veer attempting to solve the disconnect, there are theorists that have already composed solutions.

The thinkers and intellectual theorists of the Austrian School of Economics approach the Diamond-Water Paradox with heterodoxy. The true irony is that the Austrian theory of Imputation/ Subjective Theory of Value is somewhat self-evident and accessible through detective reasoning. The hegemony of scientific thought has caused the inculcation of empiricism to most educated individuals. Biasing our perspectives to the extent of overlooking a priori information. It is important to remember that economics isn’t congruent with the natural sciences. The empirical method is inapplicable to economics it is would be erroneous to apply to the social sciences (page 35) [10]. Much of economic behavior cannot be explained through material validation of experiments but through formal logic (page 25) [10].

The Subjective Theory of Value does not derive the value of goods based or other costs of production. Rather the monetary value is ascribed by the perceived importance by the consumer [11]. However, the perceived value of a commodity or service does not remain constant. The more of a good the consumer has the greater the aptitude the good has already satisfied the consumer’s most pertinent needs. Each subsequent acquisition of the specific good is then utilized for less important uses. In a sense, the good becomes less valuable the more the consumer’s need for it has become satiated. This principle is known as the Law of Marginal Utility. [12] [13] It should be quite conspicuous how it dovetails to the Law of Supply and Demand. Due to the observed and enduring fact that the scarcity does influence the value of a good. From the vantage point of the Austrian School, the determination of the change in value is made by the consumer.

Ludwig Von Mises one of the defining and premier theorists within the Austrian tradition sheds much light upon the topic of value in his masterpiece Human Action. A quintessential book and a milestone to the advancement of Austrian Economic thought. Mises surmises that the value of goods is derived through action. This implicit fact is demonstrated through the act of exchange. If we are willing to trade X amount of one commodity for another it can be assumed that we value the commodity we obtained more than the one that was exchanged. An order of value created without the aid of any formal calculations (Page 120) [14]. This notion gives credence to the possibility that goods are valued on a subjective level and this is punctuated economic behavior.

Above all Mises along with all following Austrian theorists perceives value as being a subjective attribution. However, it should be noted that the subjective theory of value was not conceived by Mises as it was Carl Menger the founder of the Austrian school that formulated this premise. What I would state is that Mises elaborated on the concept and further refined it. Beyond the circumstantial contingencies of prevalence and scarcity. Mises describes value as being (page 96)

“Value is the importance that acting man attaches to ultimate ends.
Only to ultimate ends is the primary and original value assigned. Means are
valued derivatively according to their serviceableness in contributing
to the attainment of ultimate ends. Their valuation is derived from the
valuation of the respective ends. They are important for man only
as far as they make it possible for him to attain some ends.
Value is not intrinsic, it is not in things. It is within us….” [15]

Ultimately  Mises is pointing to the fact that commodities and services are only valuable because we perceive them as being so. Whether or not an individual finds goods to be valuable is reflected in their actions which is the physical manifestation of choices. In a sense contemplation of choices is still a form of action just on a metaphysical level. Generally, the value we attach to goods and services is connected to our end goal objectives we try to achieve by obtaining the goods. When an individual purchases a luxury car, it may be due to its superior performance or the fact that it is considered a status symbol. If the individual seeks to achieve one of these goals or “ultimate ends” and believes that procuring the vehicle will satisfy their goal they will make the purchase (page 95) [16].

One pertinent question that arises from a potential blindspot within the subjective theory of value is pricing. If everyone has a subjectively determined monetary assessment of specific goods how do we arrive at the MSRP? As with any commodity, whether it is a candy bar or a Ferrari, there is a range of acceptable prices for the good. There are certain circumstances that can influence the parameters of whether the selling price goes from the higher or lower end of the bell curve (Page 76) [17]. Competition among sellers and consumers greatly impacts the selling price of a good. There are a plethora of rules that address how seller pricing and the consumer’s attribution of the price influence the final selling price. This a topic that is extremely nuanced I could dedicate an entry blog entry to it.  One example that illustrates this point is in the circumstance of isolated exchange. A circumstance where the consumer wants a good at a certain price, but not enough to surpass their subjectively determined amount. The seller has a specified dollar to sell the good at that is within the acceptable pricing range that may be lower than what the consumer is willing to purchase the commodity for. The price will be determined by which of the two individuals are more adroit at the art of bargaining (Page 77) [18].

It must be quite salient at this point that the Austrian School of Economics sees value as being determined by the perceptions of the consumer. If you place an inordinately high (beyond market price)price on a commodity it will not sell! However, how does the Subjective theory of value precisely seek to solve the Diamond-Water Paradox? Prior to the Austrian interpretation of utility, theorists were stuck due to the fact that water is more important than diamonds. To further compound the matter Labor theory failed to consider how a valuable commodity such as diamonds could be obtained in a happenstance manner. An example being discovering a diamond on a hike [19]. Certainly would not be any testament to the units of labor exhausted to obtain that very diamond. An individual faced with  “… the choice between definite quantities of goods..” the individual then chooses which set of goods will satiate the highest-ranking goal which is subjectively determined by the individual [19].  If an individual chooses to make wine with grapes versus eating the grapes it can be inferred to that individual that their need to make wine outweighed their need to consume the grapes. The production of alcohol is an excellent example of this principle. It has been speculated that the production of spirits started off as a means of utilizing surplus produce. This would reflect the luxury of delayed consumption.

 

LABOR THEORY OF VALUE:

The Labor Theory of Value is arguably the antithesis of the Subjective Theory of Value favored by the Austrian School of economics. While the Labor Theory of Value has been adopted by other economic perspectives is synonymous with Marxism. It stands to reason considering the Marxist propensity to exacerbate class envy and see economic trade as an exploitative practice [20]. I would personally argue that such a perspective obtusely ignores many of the positive externalities of unfettered trade.  That aside, I believe it is important to understand the ethos behind the economic movement that developed this interpretation of value. Without such contextual information, we do not have any context for what engendered such ideas to spawn. Especially considering it is seen as being one of the major intellectual pillars of Marxism [21].

The basis for the Labor Theory of Value does appear a little more linear and more in line with our explicit understanding. In contrast, the Subjective Theory of Value is more innate to our sensibilities, per the prism of our social conditioning, we have been trained to believe the situation is more complex than it really. Therefore requiring more detailed and extensive justification. The Roots of Labor theory of value stretch back to Karl Marx’s book Capital. It could be argued that the true genesis of Labor Theory came from Adam Smith, however, his explanation was not as robust [22]. So for all intents and purposes, the progenitor of this theory is Marx.  In his book, Marx asserts that the value of a commodity can be objectively determined by the number of hours it takes to produce the goods [22]. Leading to the assumption that the more hours put into production the more valuable the commodity is.

Marx referred to the amount of labor that one into the production of a good as the commodity of labor power.  He viewed that the correct wage to the worker for there expended labor would be enough to cover their basic necessities. However, no more than that again it is well known that Marxism in its purest forms relinquishes private property. No point in earning more compensation than what is required for sustaining life. Even if the profession is a more productive and capital intensive job. Marx takes a twisted turn into his explanation of how entrepreneurs earn a profit, even when that runs contrary to his thesis of proper compensation. He asserts that this a parasitic relationship where the surplus-value of the workers is extracted by management and capitalist. In a direct sense, they relish the spoils of the toils of the common worker. Marx further expounded upon this perceived inequality by fixating on the alienation caused by this and other asymmetrical aspects of capitalism [22]. It can be argued Marx was merely being antagonistic without any genuine concern for the sorrows of the common worker.

There is one profoundly gaping hole in the panoply of the Marxist appeal for the Labor Theory of value. That is the fact that it cannot be consistently and evenly applied to all circumstances of production. As we mentioned earlier with the example of finding a diamond on a hike would exert less ” labor power” than obtaining one via traditional mining methods [19]. However, does the means of procuring a diamond make that specific diamond less valuable? The obvious answer would be no. Another example would be the difference between the price of a loaf of bread from a grocery store versus a convenience store. The amount of labor exerted to make a mass-produced loaf of bread would not vary based on the vendor that sells. Rather it would appear that the consumer is paying more for the convenience of being able to pick up the item from the 7-11 versus the grocery store. The consumer views this price difference to be adequate due to quick access. However, this acceptance by the consumer is based on a subjective inference manifested in purchasing choices. This is no indication of any difference in regards to production.

5 thoughts on “The Diamond-Water Paradox. An Economic Puzzle.

  1. Worthwhile information, if a rambling, verbose read. Could be stated with about half the number of words that do more to confuse than elucidate the non-academic reader (myself in this instance). I think I got the gist of it however.

    Liked by 1 person

  2. A commodity of high quality, such as cognac, has greater value than a bag of spinach, because it’s a luxury and not needed for survival. A couple cans of cheap beer costs a lot less to achieve the same alcohol related benefits and can satisfy the thirst and stupor the populace requires to survive the life. Spinach (plant life) is required to keep the populace alive, cognac is not. However the stupor gained from the alcohol as a means to relax from the rigors of the life does have its place in the necessity category, which gives it lesser value. You can’t feed the populace on fifty dollar or more bags of spinach. Value at some point appears to be a function of supply and demand.

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    1. Chef Sharon, you are certainly correct in regards to how supply and demand is a pertinent variable in determining value.

      Scarce goods do tend to command a higher value in the market place than common commodities. However, scarity alone does not make goods valuable. Nor does the amount of labor exerted during production. Rather it is the subjective evaluation of the consumer is what determines if a commodity has value.

      I can produce a handcrafted chair that is “one-of-a-kind”, but if no one desires to purhcase it holds no true value.

      A fifty dollar bottle of cognac is of that value only because people are willing to pay that amound for it.

      Like

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