Sunday, July 12, 2009

A Mengerian Solution to the Diamond-Water Paradox

This post is part of a series exploring Principles of Economics by Carl Menger.  The following explores content from chapter 3.

Previously in this series: Menger on Multi-Purpose Homogenous Goods

Let us say two men want to make a trade.  One man offers water, the other diamonds.  The water seller has a reservoir of 1,000 gallons of water.  Let us say the diamond seller offers a 1-carat diamond for 100 gallons of water.  Would the water seller make the trade?  Let's say he would.  "That disproves the use-value theory of value!" the Smithian cost-of-production value theorist would insist, "Water is more useful than diamonds!"  However, the question is not whether water-in-general or diamonds-in-general are more useful.  The insight of Menger's marginalism is that it is necessary to compare the discrete quantities: one 1-carat diamond vs. 100 gallons of water.

Let's say the water seller plans on using his current water supply over the course of a month, after which his supply will be replenished from some unknown and unimportant source.  Were he to keep the whole 1,000 gallons, he would apply his supply in the following manner:

  • 100 gallons for drinking water for his family and guests
  • 500 gallons for cleaning water
  • 300 gallons for watering the plants on his estate
  • 100 gallons for water sports

According to the law discussed in the previous post, were he to give up 100 gallons for the diamond, he would give up the least important satisfaction supplied by that particular quantity of water.  Let's say the fun of playing water sports is the least important satisfaction.  And let's say the satisfaction he would gain from the diamond is the pleasure of seeing it ornament his wife's hand.  The material question is not even "which is more important 100 gallons of water or a 1-carat diamond", because these are just means to ends of satisfaction.  The end of satisfaction imputes value to the means of the good.  What most economic historians don't recognize is that it was not Menger's marginalism that was his most important contribution to value theory; it was his subjectivism, the recognition that it is the ends, the satisfactions, which must be compared.  What Menger really inaugurated was a Subjectivist Revolution.  The truly material question in the hypothetical scenario is "which is more important, the fun of a month of water sports, or the pleasure of seeing a beautiful sparkle on his wife's hand until death parted them?"  It is no paradox that most men would choose the latter.

Next in this series, Menger on Qualitatively Different Goods

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