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First propounded by Adam Smith in Wealth of Nations, the paradox of value is also known as the diamond-water paradox. The apparent contradiction is that, although water is essential to life while diamonds have mostly aesthetic value, the price of water is vastly lower than that of diamonds. The theory of marginal utility, an attempt to resolve this paradox, brought about the birth of neoclassical economics. There is no classical solution to the paradox, although attempted solutions are discussed below. Of the several neo-classical solutions proposed, all start with the realization that classical economics suffered from the fallacy that value is an inherent quality of a good--that is, that water is intrinsically valuable in the sense of its use value, while diamonds are intrinsically valuable in terms of their economic value. The paradox, then, is that items with a high use value often have a very low economic value. To counter this fallacy, one considers a man lost in a desert with a sack of diamonds over his shoulder. If, on the point of death, he meets another man with a jug of water, he will gladly trade any number of his diamonds for that one jug of water. This demonstrates that the economic value of a good, at least, depends on circumstances and not purely on the intrinsic properties of the item itself. In the desert scenario, the paradox doesn't appear to hold at all, and water is indeed valued more highly than diamonds. Where neoclassical theories differ is in their explanation of value itself. Once it is admitted that value can vary with circumstances, the question becomes, "Where does value actually come from?" The above desert scenario suggests another key idea found in every attempt to answer the question: namely, that the value of water rose when it became scarce. Intuitively, water is valued less than diamonds because it is so readily available. At the extreme, notice that air is even more necessary than water, yet air is not even considered an economic good, because it is freely available to everyone. (SCUBA divers, by contrast, actually do purchase air.) Broadly speaking, the difference is one of scarcity. Adam Smith actually proposed a solution to the Diamond-Water Paradox, but his solution suffered from the assumption that the value of diamonds never changes--i.e., he did not take into account the preceding scenario and others like it. He hypothesized that the difference between diamonds and water is that diamonds require more labor to produce. Thus the value of water is the cost of raising a bucket from a well, while the value of a diamond is the cost of mining it, cutting and setting it, etc. This hypothesis breaks down when one considers that in the desert scenario, the production cost of the water is still much lower than the production cost of a diamond, yet the water is valued more highly than the diamond. It may fairly be said, however, that Smith was working from the same intuition as the neoclassical economists, where his notion of "labor" stood proxy for the intuitively-relevant idea of scarcity. A more serious objection to the idea of intrinsic value, however, can be illustrated by another example. There is a community in the United States whose members are forbidden to use ornaments of any kind--including buttons on their clothing. They do not purchase jewelry. Ignoring industrial uses of diamonds, they have no value at all in this community. Supposing this community's views caught on everywhere, what would happen to the value of diamonds? Suddenly diamonds would be valued less than water. A diamond that once commanded a high price could suddenly not be sold at all. Yet no property of the diamond has changed, in the interval that it fell from a very high value to essentially no value. This suggests that the value of a good has nothing to do with the properties of the good itself, and everything to do with people's attitudes toward the good. Thus was born the notion of subjective value: the value of a good rests in the desire of others to have it. Although water, for example, is a necessity, people will not desire a particular supply of water when plenty of alternative sources exist. When few sources exist, as in the desert, the value of a particular amount of water increases. By itself, this solves the paradox of value, without directly explaining the value of any good. A good is worth so much, because that's how highly people value it, and nothing more can be said. Around 1870 William Stanley Jevons in England, Carl Menger in Austria and Leon Walras in Switzerland took this reasoning a step further, inventing the concept of marginal utility: a good is valued in terms of its least-productive use. The reasoning goes like this. If someone posesses a good, he will use it to satisfy some need or want. Which one? Naturally, the one that takes highest-priority. Eugen von Böhm-Bawerk illustrated this with the example of a farmer having five sacks of grain. With the first, he will make bread to survive. With the second, he will make more bread, in order to be strong enough to work. With the next, he will plant his field next year. The next is fed to his farm animals, and the last one he feeds to the pigeons. If one of those bags is stolen, he will not reduce each of those activities by one-fifth; instead he will stop feeding the pigeons. So the value of one bag of grain is equal to the satisfaction he gets from feeding the pigeons. If he sells that bag and neglects the pigeons, his least productive use of the remaining grain is to feed his animals, so the value of one more bag of grain is the value of his animals' living another year. Only if he loses four bags of grain will he start eating less; that is the most productive use of his grain. The last bag of grain is worth his life. The productiveness of the least productive use for a good is its marginal utility. As the example illustrates, marginal utility decreases as the supply of a good increases, and vice versa. Thus marginal utility neatly explains why the last bottle of water in the desert is worth life itself, while ordinarily a bottle of water is worth very little. It should be stressed that this is still a subjective theory of value: diamonds are valued highly because the marginal utility of a diamond as an ornament is very high, but that is so only because people consider ornamentation important. If everyone converted to the Amish way of life, the marginal utility of diamonds would fall because, subjectively, ornamentation has ceased to be an important value to people. What does Paradox of Value mean ? 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