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Nonetheless, society generally assumes that extra income would yield more utility to a lowincome
person than to a high-income person. And hundreds of billions of dollars in income are
redistributed each year, generally from persons with more income to persons with less income,
with the goal of increasing total utility for society. (We will look more closely at income distribution
and redistribution in Chapter 31.)
Diamond-Water Paradox
Is the price of a good related to the utility received from consuming the good? Logically, we would
expect the price of a good to be related to the good’s utility. If Bertram is willing to pay $6 for a
chili dog, Bertram must be anticipating at least $6 worth of utility from consuming the chili dog.
But what about the diamond-water paradox?
Diamond-water paradox – the observation that essential goods are often lower priced than nonessential
goods.
Some goods that are essential to life (like water) have a very low price. Other goods that are nonessential
(like diamonds) have a very high price. This seems paradoxical. Shouldn’t a good’s
price be related to its utility? Actually, it is. The price of a good is equal to the marginal utility of
the last unit of the good consumed. This is the explanation of the diamond-water paradox. Water
has a very high total utility. A person would be willing to pay a very high price to have sufficient
water for drinking purposes.
Example 6: If the only source of drinking water had a price of $20 per gallon, a person would
willingly pay the high price rather than perish from thirst.
But a person consumes many units of water, for a variety of uses. The first units of water
purchased have very valuable uses, such as drinking. As more units of water are consumed less
valuable uses are made of water, such as bathing, washing clothes, washing cars, watering
flowers, etc. The last units of water consumed have a very low marginal utility, and are consumed
only because of the very low price of water. If water had a price of $20 per gallon, a person would
not buy water for its less valuable uses. (Good luck, flowers, you are on your own.)
A person consumes few diamonds. The last diamond consumed has a very high price, and is
consumed only because the buyer expects a very high marginal utility. If diamonds were more
abundant and had a lower price, they would be consumed for less valuable purposes. If
diamonds were as abundant as gravel, they would be used to pave driveways. So which is more
valuable, water or diamonds? Water is more valuable than diamonds in terms of total utility, but
diamonds have a higher marginal utility, and thus a higher price.
Example 7: Pat buys a diamond engagement ring in March, paying $2500. Pat’s water bill in
March is $30 for 1,500 gallons of water, or an average price of 2¢ per gallon. The diamond ring
provides Pat with more marginal utility than the fifteen hundredth gallon of water (which dripped
out of a leaky faucet). But the water that Pat consumed in March provided Pat with more total
utility than the diamond ring.
Utility Maximization
Consumers will attempt to maximize the utility (satisfaction) that they receive from their limited
incomes. To determine the utility-maximizing combination of goods to consume requires
consumers to consider how much marginal utility different goods yield, and also the prices of the
different goods. To illustrate this, assume that Consumer A is trying to choose the combination of
Good X and Good Y that will maximize Consumer A’s utility. Good X and Good Y yield the
amounts of total and marginal utility to Consumer A indicated on the table on the next page:
FOR REVIEW ONLY - NOT FOR DISTRIBUTION
18 - 3 Utility