The Economic Value of Diamonds

Readers Question: Why are Diamonds very expensive and water very cheap, when diamonds are useless, but water is essential for life?

The first question is – how many diamonds do you buy during your lifetime? How often do you consume water?

The average person will buy maybe 2 or 3 diamonds. 1 as a wedding ring, 1 for a 25 year wedding anniversary. There is a high marginal benefit (utility) of buying your wife a diamond for her wedding. True love is priceless, but, diamonds don’t do any harm to a relationship. However, if you bought a second diamond a week after the wedding, this would have a significantly lower marginal benefit. The diamond wedding ring is special because it is a one off. If you buy a diamond every week these extra diamonds give little if any benefit. Therefore, we are willing to spend so much on diamonds because we only consume a very small number.

However, water is very different, we buy water today, but, we need to keep buying it everyday for the rest of our life. Luckily the supply of water is vast, meaning that it can be supplied at a very low price.

Water is cheap at the margin, and therefore cheap to buy. But, the total utility of water is much higher than the total utility of diamonds. The difference is the quantity purchased and availability of supply.


By on December 1st, 2007