Lesson 1 of 7
Why water was a problem
Classical economics could not say why water is cheap and diamonds are dear. The puzzle needed a better question, not a better answer.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- The puzzle is that the most useful goods are often the cheapest, which no account that locates value in usefulness can explain.
- Locating value in labour does not fix it either, because plenty of laborious things are worthless and plenty of valuable things took no labour.
- The puzzle dissolves once you notice that nobody ever chooses between all the water and all the diamonds. They choose about one more unit.
Water keeps people alive and is nearly free. Diamonds keep nobody alive and are expensive. For a long time that was a real problem for economics, because the obvious explanations of value predict the opposite.
The question that could not be answered, and the question that can
As it was asked
- Why is water worth less than diamonds?
- Compares the whole class of one good with the whole class of another.
- Answers offered: total usefulness, or labour embodied.
- Both predict water should be dear.
As Menger asks it
- Which would you rather have one more of, right now?
- Compares one additional unit with one additional unit.
- The answer depends on how many you already have.
- Predicts cheap water and dear diamonds without strain.
The second question has an answer, and the first one does not.
Why usefulness does not work
If value came from how useful a class of goods is, water would be the most valuable thing there is. It is not. Worse, the same good changes price dramatically with circumstances that leave its usefulness untouched: water is nearly free in a city and very expensive to a person carrying it across a desert, and it does the same job in both places.
Why labour does not work either
The other classical answer is that value comes from the labour that produced a good. This runs into trouble immediately in both directions. A great deal of effort can produce something nobody wants, and the effort does not make it valuable. And things that took no labour at all, a piece of land that happens to sit where a road is about to be built, can be worth a great deal.
Menger addresses this directly in chapter III of Principles of Economics, where he argues that labour is not the measure of value and that treating it as one is an error about where value comes from. His own account runs the causation the other way, and the next three lessons follow it.
Where the puzzle actually goes
The puzzle is not solved. It is dissolved, which is a different thing. Once you see that a person never decides between all the water in the world and all the diamonds, the comparison the paradox depends on stops being one anybody makes.
What a person decides is whether to have one more glass, or one more stone. And what one more of something is worth to them depends entirely on how much of it they already have, which is the subject of the next lesson.
Check yourself
Why does total usefulness fail to explain the price of water?
- Because water has no uses
- Because water is enormously useful in total and still cheap where it is abundant
- Because usefulness cannot be measured at all
Show the answer
Answer: B.
An account that ties value to the usefulness of a whole class of goods predicts that the most useful class is the dearest. Water is the standing counterexample.What is wrong with locating value in the labour that produced a good?
- Labour is hard to measure
- Laborious things can be worthless and valuable things can take no labour
- It applies only to manufactured goods
Show the answer
Answer: B.
The counterexamples run in both directions, which is why Menger treats labour as a consequence rather than a cause of value in chapter III.What does Menger change about the question?
- He compares classes of goods more carefully
- He asks about one additional unit rather than about the whole class
- He measures usefulness on a common scale
Show the answer
Answer: B.
Nobody chooses between all water and all diamonds. The choice is always about one more unit, and that is the comparison the next lesson works through.Sources
- Menger, Principles of Economics, 1871, English translation 1950, chapter III, on the nature and origin of value and on the subjective character of the measure of value, including the argument that labour is not its source.
- Menger, Principles of Economics, chapter II, on requirements and available quantities, which is where the relation that produces the paradox is set out.
What this leaves out
- This is a heterodox tradition. The mainstream account of the same phenomenon differs, and nothing here is a forecast or a view on any security.
- The water example uses invented circumstances to isolate one point. No prices here describe any market.
- Marginal utility was not only Menger's, and the next lesson names the two economists who reached it independently in the same period.