Question

How does marginal utility explain the diamond-water paradox? What are the weaknesses of marginal analysis in the first generation? Explain the marginal analysis of the second generation.

Answer 1

Adam smiths diamond water paradox theory noted that, water is more essential for the existence of human life, but the value of diamond is much more higher compared to that of water. But this paradox was unsolved until the economists named leon walras, stanley jevson and william stanley combined 2 theories. They proved that the economic decision making are based on marginal benefit rather than total benefit.

Total benefit or utility means, the overall satisfaction achieved from the wants and needs by consuming the good. Marginal utility is the extra satisfaction obtained from consuming goods. Since water is plently available its utility is linked with total utility. But diamond is rare hence when purchasing it extra satisfaction is achieved. The marginal utility of diamond is higher than that of total utility of water. This is known as principle of marginal utility.

First generation marginalists applied marginal analysis exclusive to theory of demand and ignored theory of supply. They did not explained the factors which determine the price of product, no explanation of factors deciding distribution of income. They did not analysed the firms and also didnot explained wages, rents etc.

In second generation marginal analysis, they applied the theory into production theory, production cost theory, distribution theory etc. Theory of production explains the optimal condition for employment and their factors. Theory of distribution explains relative income of factors of production. Second generation marginal analysis was influenced by progress in mathematization.