Adam Smith on Value

The word value, it is to be observed, has two different meanings, and sometimes expresses the utility of some particular object, and sometimes the power of purchasing other goods which the possession of that object conveys. The one may be called "value in use"; the other, "value in exchange." The things which have the greatest value in use have frequently little or no value in exchange; and, on the contrary, those which have the greatest value in exchange have frequently little or no value in use. Nothing is more useful than water: but it will purchase scarce anything; scarce anything can be had in exchange for it. A diamond, on the contrary, has scarce any value in use; but a very great quantity of other goods may frequently be had in exchange for it.

For Smith, "value in use" is utility, and "value in exchange" is price. That's what we call these notions today.

And he's laying out the puzzle of why a good as useful as water trades at a price so low compared to entirely useless sparkling stones. And of course, of course, of course, the first drink of water is beyond any substitute. Nothing can replace it. The thousandth gallon has no use at all. Tricky. The "value in exchange" (the price) derives from the "value in use" (the utility) of the very last gallon, not the first parched drink. Very tricky. Smith got it wrong. It took people another hundred years to untangle that knot, but when the pressure was too much, the dam burst in spectacular fashion. Three different people independently came up with the solution. Now that is an idea whose time had come, better even than the calculus.

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