Commentary: The diamond-water paradox is a problem that has long flummoxed thinkers about market economies. It arises from the observation that a useless sparkly stone that is a diamond can be worth thousands per carat, while something essential for life—water—costs only fractions of a penny per gallon.
The solution to this paradox is to recognize that the price reflects not the average value, but the value of the last unit. If you have gone three days without water, that first glass would be worth literally the price of your life. The second glass would also be quite valuable. The third glass less valuable but still very welcomed. Ultimately, as the available water increased, the next glass would be less and less valuable.
For the typical Las Crucen, water is so plentifully that the price of a gallon is few tenths of a penny, so cheap that we use water for rather frivolous things, like watering lawns and flushing toilets. But that does mean that the first glass is any less valuable, as it is still necessary to sustain life. What this does mean is that the first glass is a real bargain—survival for a pittance. Meanwhile, diamonds are much rarer, so cost much more, despite being of such little value for survival.
The diamond-water paradox pops up in many settings. Recently, for example, I read an article that claimed that MBAs are more valuable to society than are business PhDs as MBAs go on to be CEOs of successful companies, earning high salaries while business PhDs, the ink stained wretches that we are, earn much less. Clearly,
CEOs are a rare breed. MBA programs can help to transform an average business person into one, but not reliably. Because good CEOs are hard to come by, like a diamond, they come at a high price. Business PhDs are much more plentiful. Moreover, we know how to train PhDs, so if the price is right, we can have as many as we want. Like plentiful water, their salaries are less.
But nothing about salaries says anything about the total social value of PhDs vs. CEOs. In fact, the business PhDs, by training students about best practices, have an enormous impact on productivity. It just that PhDs come cheap, not that they are don’t compensated as much as CEOs.
Each college course corresponds, according to Census Bureau calculations, to about $15,000 in present value of future earning capacity per student. Times the typical 20 students per class, that $300,000 of value added per class. A pretty good deal given faculty pay.
Diamond-water paradox is also relevant when talking about school teachers. One study found that a teacher in the top third, as measured by student achievement tests, increase the future earnings of a typical student’s future earnings by $400,000 in classroom of 20 students compared to an average student.
So a top third teacher contribution to society, as measured by her students earning power, is $400,000. How many classroom teachers are paid $400,000? I’d guess none.
Christopher A. Erickson, Ph.D., is a professor of economics. He is also CEO of his family business, a forest products business based in Oregon. He believes his contribution to society as a professor far exceeds his contribution as a CEO. Opinions expressed may not be shared by the regents and administration of NMSU. Chris can be reached at chrerick@nmsu.edu.