Economics: A Contemporary Introduction 9th Edition by William McEachern

Exercise 7

Case Study: Water, Water Everywhere What is the diamonds water paradox, and how is it explained? Use the same reasoning to explain why bottled water costs so much more than tap water.
Reference Case Study:
Bringing Theory to Life
Water, Water, Everywhere Centuries ago, economists puzzled over the price of diamonds relative to the price of water. Diamonds are mere bling--certainly not a necessity of life in any sense. Water is essential to life and has hundreds of valuable uses. Yet diamonds are expensive, while water is cheap. For example, the $10,000 spent on a high-quality one-carat diamond could buy about 10,000 bottles of water or about 2.8 million gallons of municipally supplied water (which sells for about 35 cents per 100 gallons in New York City). However measured, diamonds are extremely expensive relative to water. For the price of a one-carat diamond, you could buy enough water to last two lifetimes.
How can something as useful as water cost so much less than something of such limited use as diamonds? In 1776, Adam Smith discussed what has come to be called the diamonds-water paradox. Because water is essential to life, the total utility derived from water greatly exceeds the total utility derived from diamonds. Yet the market value of a good is based not on its total utility but on what consumers are willing and able to pay for an additional unit-that is, on its marginal utility. Because water is so abundant in nature, we consume it to the point where the marginal utility of the last gallon purchased is relatively low. Because diamonds are relatively scarce compared to water, the marginal utility of the last diamond purchased is relatively high. Thus, water is cheap and diamonds expensive. As Ben Franklin said "We will only know the worth of water when the well is dry."
Speaking of water, sales of bottled water are growing faster than any other beverage category-creating a $15 billion U.S. industry, an average of 25 gallons per person in 2010. Bottled water ranks behind only soft drinks in sales, outselling coffee, milk, and beer. The United States offers the world's largest market for bottled water-importing water from places such as Italy, France, Sweden, Wales, even Fiji. "Water bars" in cities such as Newport, Rhode Island, and San Francisco feature bottled water as the main attraction. A 9-ounce bottle of Evian water costs $1.49. That amounts to $21.19 per gallon, or nearly 10 times more than gasoline. You think that's pricey? Bling
is available in bottles decorated with Swarovski crystals and sells for more than $50 a bottle-that's about 100 times more than gasoline.
Why would consumers pay a premium for bottled water when water from the tap costs virtually nothing? After all, some bottled water comes from municipal taps (for example, New York City water is also bottled and sold under the brand name Tap'dNY). First, many people do not view the two as good substitutes. Some people have concerns about the safety of tap water, and they consider bottled water a healthy alternative (about half those surveyed in a Gallup Poll said they won't drink water straight from the tap). Second, even those who drink tap water find bottled water a convenient option away from home. And third, some bottled water is now lightly flavored or fortified with vitamins. People who buy bottled water apparently feel the additional benefit offsets the additional cost.
Fast-food restaurants now offer bottled water as a healthy alternative to soft drinks. Soft-drink sales have been declining for more than a decade as bottled water sales have climbed. But if you can't fight 'em, join 'em: Pepsi's Aquafina is the top-selling bottled water in America, and Coke's Dasani ranks second.