Why are diamonds so expensive?

We all know that quality natural diamonds are expensive gemstones to buy. But why should that be? After all, they're basically just compressed carbon.
The usual answer is "supply and demand": diamonds are rare, diamonds are popular, so diamonds are expensive. That's true but not the whole story.

Diamonds are not especially rare, they haven't been since huge deposits were found in South Africa over a hundred years ago. Physical scarcity isn't the issue. So why are diamonds so expensive?

Supply

Although there is a huge supply of diamonds, not all diamonds are created equal. In the jewelry trade diamonds are usually judged according to the "four Cs": Carat (weight), Clarity, Colour and Cut. These provide for product differentiation between the huge numbers of diamonds that could be dug from the ground.
The first three Cs - Carat, Clarity and Clour - are determined naturally. Applying these criteria alone reduces the naturally available supply of "quality" diamonds drastically. Most of those that fall by the wayside are used for industrial purposes, even though to a layman many of them might look just as attractive as "gemstone quality" diamonds.

The fourth C, Cut, is an entirely artificial distinction. Cutting a stone brings out its natural beauty and the difference between a good cut and a poor one can make or (metaphorically) break a diamond. A number of standard cuts have evolved over the years, some of which are more complex and sought after than others.

Cutting diamonds is a skilled craft so the distinction between cuts is another way that the supply of quality diamonds is effectively restricted.

Recently it has become undesirable to trade in conflict diamonds (also known as "blood diamonds"). These are diamonds which it is believed are mined to help regimes raise money to wage war or oppress their people. This provides a political restriction to the worldwide diamond supply.

Finally, it's worth noting that the vast majority of the world's diamond supply is controlled by just a few large companies. It's clearly not in their interests to flood the market.

Demand

Why are diamonds so popular? There are many other gemstones, many of which are (at least in my opinion) just as attractive.
The popularity of diamonds is the result of one of the most successful marketing campaigns in history. This was largely orchestrated by De Beers and included product placement as well as celebrity and royal associations. The modern symbolism of diamonds along with the idea of the diamond ring as a perfect gift of love are largely creations of the marketing departments.

The result is that demand for diamonds is higher than might be expected if they were compared with other gemstones simply in terms of their appearance. They have acquired an aura and hence desirability beyond their physical properties.


So to return to the original question: why are diamonds so expensive? Because the supply of quality diamonds - in terms of Carat, Clarity, Colour and Cut - is low and the demand for them has been raised by very effective marketing.