Why are diamonds more expensive than water even though the demand for water is higher?
In spite of being a necessity and having a lot more utility than diamonds, water has a very low price when compared to that of diamonds.
This is something that has puzzled economists for a long time and has popularly come to be known as the water-diamond paradox.
One way of explaining this phenomenon is with the use of a concept called marginal utility. Marginal utility refers to how much one extra unit of a product is able to satisfy the requirements of a person. In the case of water, the marginal utility is very low, while in the case of diamonds it is very high. This is due to the fact that we already consume such a large quantity of water that the extra satisfaction we gain from a little more water is very little. On the other hand, people usually do not have more than a few diamonds with them. This gives an extra diamond the ability to provide a lot of satisfaction.
The price of a product is totally dependent on its marginal utility. Higher marginal utility increases the price and a lower marginal utility decreases it. This explains the pricing of water and diamonds.
While it is true that there is a large demand for water, there is also a large supply of it. Potable water is still in abundance on Earth. While water imported from exotic locales can be a little more expensive than local water, people still consider the supply of water to be abundant.
Diamonds, on the other hand, are scarce. While the demand for water is higher, diamonds are still more expensive. The supply of diamonds is controlled and many diamonds require processing either for jewelry or industrial purposes before they are used. In order to create a higher price for diamonds, producers scale back their mining efforts or do not release as many to the public. Also, diamonds are not always in demand, unlike water.
In economics, supply is just as important as demand when it comes to determining a purchase price in a free market. While water is more useful than diamonds, there is more of it and it's supply for now is quite constant. Diamonds, on the other hand, are rather scarce, especially high-quality gems. This leads to higher diamond prices.
Diamonds are more expensive than water because they are hard to find in comparison to water. Water bodies are everywhere we look; it is hard to go somewhere without seeing a river or a lake. In fact, our continents are surrounded by oceans and seas. As a result, anyone can go to a body of water and collect water for themselves. The monetary value of an item is largely determined by its availability. To find diamonds, one has to dig deep in the ground to collect the mineral. Then, it has to be separated from the ore- a process that can be quite expensive and extensive. By the time, the diamond reaches the jewelry shop, it has cost the mining company thousands or sometimes millions of dollars to be produced. The miner transfers that cost to the jeweler, who then transfers it to the buyer. Thus, the reason why diamonds are so expensive.
When you think about the price of a good or service, you must not just consider demand. You must also consider supply. It is because of this other factor (supply) that diamonds cost so much more than water does.
The price of an item (if there is no government interference) is determined by both supply and demand. If you graph the supply curve and the demand curve, the good will be sold at the price (and quantity) where the two curves intersect.
Because water is so much more abundant than diamonds, there is a much larger supply of it. In general, the greater the supply of something, the lower the equilibrium price. This is why diamonds cost more than water even though water is a necessity and diamonds are not.