Lecture 7: Water Economics Flashcards
What is the diamond water paradox?
Water: essential for life and low value/price
Diamond: non-essential for life and high value/price
Explain the concept of marginality
what matters is the value of an
additional unit of a good, regardless of the value of the
previous unit
Explain the concept of scarcity
The value of a good is thus also determined by its scarcity
(determined by the relation of supply and demand)
—> A reversal of diamond and water prices may occur once
the marginal water uses are essential uses
What are characteristics of water?
Essential, needed for survival
Finite and non-substitutable
Mobile, fugitive, a flux
A system
any use of water affects the whole water cycle
Varying availability and quality
—> spatial and temporal variability (climate variability, land
use, human interference…)
Specific characteristics of water (2)
Bulky
—> difficult to store
—> limited transportability (or only within limits)
Use may create externalities
—> dependencies between users (e.g. upstream and downstream users)
Various uses/users, so water market is not homogenous
What are the different users of water?
Households —> drinking water, household water
Industry, Construction, Mining —> production processes
Agriculture —> irrigation water
Transport sector —> oceans, rivers, but also ballast water
Energy sector —> hydropower, other energy sources
Tourism —> recreation, swimming, water sports
What are the implications of the characteristics and uses of water?
Everyone should have access to water needed for survival
—> basic water supply for free because it is essential?
There is not only one water market but markets for each type of use
The value of water differs between different uses (more and less essential uses of water)
We need to manage competing uses
We need to take into account system-effects of water use
We cannot trade water as any other good (only virtually)
How is water supplied?
Water is mostly supplied by a single provider (water utility)
Specialized to serve one user group, e.g. provider of urban water services, provider of irrigation water for agriculture
Goal: Handle raw, unprocessed or natural water from a surface watercourse or an underground aquifer —> transform the water into the retail water that is received by the clients
What are the costs of water supply?
High initial capital investment needed (fixed cost)
Variable costs include, e.g. costs for pumping, purification, decontamination, transportation to client, administrative, management cost etc.
Costs of water supply increase with amount of (retail) water that is delivered
What is the efficient supply of water?
Supply curve equals marginal cost curve —> marginal-cost pricing
Explain the water demand curve
Different demand curves for different uses and types of water
Marginal benefits function determines water demand curve of
single user
Market demand: aggregate marginal benefits function of all users
What is the price elasticity for residential water demand?
Price elasticities for residential water demand are typically in
the range of -1.3 to 0.1 with the average elasticity around
- 0.4 —> rather inelastic demand
What are the instruments of public water management?
Quotas – setting upper limit to water use for a certain purpose
License to use – issuing licenses for withdrawals or discharges
Subsidies, grants – subsidizing water-saving appliances and infrastructures
Penalties – financial and legal enforcement incentives (fines and premiums)
User charges – pricing of water services
Tradable water rights – creation of a water market where users can buy and sell water rights Instruments of public water management
What are the primary goals of water pricing?
Economic efficiency: economically efficient allocation of existing supplies
Environmental sustainability: reducing consumption, conserving water resources (for future generations)
Equity / Affordability: equitable treatment of water users, universal access
Generation of revenues / Financial sustainability: generation of adequate revenues for the operation, maintenance and expansion of the water system (cost recovery)
—>Challenge: to keep the different goals in balance
Explain water in a narrower sense
Water price: volumetric price placed on metered water
Water rate or water tariff: entire package of charges applied by a water supplier
Charges dependent on amount used: per-unit charges
Charges not based on amount used: connection fees, irrigated acreage charges
—> Typically: different water prices for different types of water and different uses
What are the three structures of water pricing? And which one is the most efficient?
Uniform Rate Structure
Increasing Block Rate Structure —> Most efficient
Decreasing Block Rate Structure
What are different household water tariffs?
Flat tariff —> fixed payment
Volumetric tariff —> pay per use
Tiered tariff —> rates that change
depending on time or amount of use
- dual rate for peak- and off-peak-demand
- Increasing block tariffs or a stepped tariff
—>Highest value use (essential water use) is priced lowest
—> Lowest value use (non-essential water use) is priced highest
Two part tariff —> fixed charge that is independent of the consumed amount and variable charge that depends on the consumed amount
Mention different types of irrigation tariffs
Flat tariff
Volumetric rate —> constant rate per cubic meter
Rising block tariff
Two-part tariffs: fixed charge per area plus volumetric rate
Per area prices
—> charges are related to the irrigated area
—> Sometimes contingent on the crops grown and/or the
season
What are wastewater tariffs and pollution charges?
Charges to treat and manage wastewater
In OECD countries: often two part tariff, fixed and a volumetric rate
Additional role of wastewater tariffs: pollution prevention
—> “Polluter pays principle”: higher charges for users that release more pollutants into the water
Explain the goal of Cost recovery and sustainable financing
Cost recovery is a prerequisite for equitable and universal access to basic water supply
Free water dilemma: Water provider will not be able to adequately maintain the system —> unsafe water for poor, while richer people can afford buying from other sources
Sustainable cost recovery is often based on affordable water
tariffs and other sources of funding (taxes, transfers)
In EU: cost recovery of variable costs is generally high for household water supply, but government subsidies are often needed for capital investments
In many low income countries cost recovery is not achieved
Explain the goal of Increasing water use efficiency
Volumetric tariffs are more effective than flat tariffs in
achieving water use efficiency
Block tariffs or a stepped tariff system can ensure universal
access:
- Highest value use (essential water use) is priced lowest
- Lowest value use (non-essential water use) is priced
highest
Explain the goal of reducing consumption
If water demand exceeds supply, then the price is too low
Efficient pricing is usually equivalent to marginal cost pricing
- Connection charges should reflect the marginal costs of connections
- Cost of (metered) water use should reflect marginal costs of supply
Additional measures to reduce water demand may be needed (e.g. education, non-price measures, technical measures, nudges, etc.)
Explain Supply-demand cycles and reservoir effects
Building dams/expanding reservoirs as
supply enhancement strategy to cope with droughts and water shortages can be problematic
Supply-demand cycles: increasing water supply enables higher water demand
—> additional supply enables agricultural, industrial or urban expansion
Reservoir effects: overreliance on reservoirs increases vulnerability
—> reduced incentive for adaptive actions on other levels
Often better solution: demand management
What are the conditions for well functioning water markets?
Well defined and administered water rights embedded in law
Large number of potential buyers and sellers
Sales and water use is monitored and enforced
Low transaction costs (administrative complexity, trading fees)
Exchange is easy
What is essential for the functioning of water markets?
Application of the market mechanisms
Assign property rights to (quantity of) water and allow trade
Market puts a price on water
Often implemented in very water-scarce countries or areas such
as
- Australia (e.g. Murray Darling Basin)
- Western parts of the US (e.g. California, Colorado)
Explain Water markets goal: Re-allocating water between
users
Different uses of water create different added value
Initial allocation of rights to use water is an administrative procedure
Price mechanism can be used to re-allocate water between users, e.g. from users with lower added value to users with higher added value
—> tradable water rights
Explain Water markets (markets for tradable water rights)
Setting an optimal price is difficult
—> We don’t know MBs
—> So exchange of water rights between buyers and sellers
Government or community limits (caps) water use within a freshwater source and defines water rights that are traded among users —> often caps fluctuate with availability
Tradable water permits: allocated permits or water rights, openly traded among users
Users with highest value for water will have highest willingness to pay for water permits
—> economic efficiency
Incentivizes investments in water use efficiency
