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Demand and Supply usually determine prices, and the theory explains the differences of diamonds and water prices perfectly.>>
The key being "usually" determine prices.
DeBeers controls sales on 2/3 of the world's Diamonds. At fixed times the each year they offer "sight holders" an opportunity to buy diamonds. The prices and quantity are fixed and non-negotiable.
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There's also
http://www.straightdope.com/columns/040903.html
and
http://www.shaneco.com/jewelry/debeers.asp
Diamonds cost what they do because DeBeers says they cost that much.