Water Prices and Values

1. Water Prices and Values John Braden University of Illinois, USA Visiting, Katholieke Universiteit Leuven Lecture 1 Leuven, Belgium March 2004

2. Outline of Lecture Series • Prices & Values • Managing Water Demand • Agricultural Pollution • Urban Stormwater & Flooding • River Pollution

3. Outline – Lecture 1 • Economic significance of water • Why care about economic value? • How is economic value determined? - Market prices - Constructed prices 4. Application to water resources

4. Helpful Resources • Gibbons, D. 1986. The Economic Value of Water. Resources for the Future. • Moons, E. 2004. The Development and Application of Economic Valuation Techniques and Their Use in Environmental Policy—A Survey. Center for Economic Studies, KULeuven.

5. What is distinctive about water? • Fundamental • Humanity • Ecology • Total value vs. marginal value • Value in situ as well as in use • Seasonal and variable • Fugitive (sometimes) • Renewable (usually)

6. Economic Importance of Water • Drinking & sanitation • Industrial processes • Aesthetics & culture • Recreation • Navigation • Power • Agriculture/irrigation • Habitat/ecosystem • Flooding (renewal, erosion)

7. Why assign economic value? • Choices between uses (water & public funds) • Optimal regulation • Provision of public goods (ecosystems, recreation, aesthetics) • Cost-benefit analysis • Liability • Damage claims

8. Value and Price • Intrinsic utilitarian (instrumental) • “Economic Value” ~ Willingness to Pay. • Price = Marginal Willingness to Pay

9. Economic Value (Benefits) Px (€) Marginal benefits ~ “demand curve” Willingness to pay = Total benefits to consumers X

10. Opportunity Cost of Supply Px (€) Marginal costs ~ “supply curve” Total variable cost of supply X

11. Balancing Benefits and Costs Px (€) “Consumer surplus” Supply ~ MC Px* Return to fixed factors Demand ~ MB X x*

12. Market Prices & Economic Value • Competition: Price = MB* = MC* • “Pure case”; useful approximation • Max consumer surplus; Min profits • Small changes • Limitations • Uncompetitive market • Disequilibrium • Policy distortions • Nonmarket goods

13. Constructed Prices a) Adjusted market prices (trade or policy distortions) • Analysis of complementary goods • Analysis of substitute goods • Stated preferences: -- contingent valuation -- conjoint choice -- experimental valuation

14. a) Adjusted market prices (e.g.) • Monopoly: P = MB > MC • Separate estimation of cost • Policy distortions • E.g., subsidies: estimate subsidy-free prices • Variation in space or time • Sensitivity/robustness analysis

15. b) Analysis of complementary goods • If A must be consumed to obtain B, then the value of B is embedded in A PA Value of B MBA w/ B MBA no B A

16. Examples using complementary goods • Derived demand: value of irrigation water derives from net increase in crop value • Property hedonics: value of local environmental quality capitalized into real estate prices E.g.: Residential properties close to hazardous waste sites regularly show 8% - 15% discounts in average prices, after adjusting for other factors. Cleanup can eliminate the discount

17. complementary goods (cont.) • Recreation travel costs: Visitation patterns and costs reveal site demand and benefits Cost of Travel “choke” price Visit trips

18. c) Analysis of substitute goods • Replacement cost • E.g., Value of a destroyed wetland = cost of constructing a replacement • Cost of aversion or mitigation • E.g., Value of clean air = avoided medical costs + lost wages + discomfort due to dirty air • E.g., Value of safe water = added cost of home filters or bottled water used instead of regular tap water

19. Substitutes reflect supply Px (€) Generally underestimate economic value Benefits~value Px* Cost of provision X x*

20. d) Stated preferences: contingent valuation • Surveys asking respondents to value hypothetical scenarios • “Best practices” • Various elicitation schemes

21. Sample CV elicitation questions • Open-ended: How much would you pay annually in additional taxes to ensure that fish in the Dilje River are free of chemical contamination? € _____ • Payment card: • How much would you pay per year in additional taxes to ensure that fish in the Dilje River are free of chemical contamination? (Choose one of the following) € 0 € 10 € 20 € 40 € 70 € 80 or more

22. Sample CV elicitation questions (cont) • Referendum • Would you pay € 40 per year inadditional taxes to ensure that fish in the Dijle River are free of contamination?Yes __ No __ • Double-bounded referendum • Would you pay € 40 per year inadditional taxes to ensure that fish in the Dijle River are free of contamination? ___ Yes. Then, would you also pay € 60 per year? Yes__ No __ ___ No. Then, would you pay € 20 per year? Yes __ No __

23. d) Stated preferences:Conjoint Choice • Marketing research • Attribute-based • Probabilistic choices • Choices reveal tradeoffs between attributes (including price)

24. Sample Conjoint Choice Question • Which home do you prefer? • The home described above • My current home

25. d) Stated Preferences:Experimental Valuation • Experimental valuation • Choices in laboratory settings with real payments • Better for behavioral diagnosis than applied valuation

26. Critique of Valuation Methods • Market methods • Actual behavior • Indirect • Analysis imposes many assumptions • Difficult econometrics • Stated preference methods • Intentions, not actions (except for experiments) • Direct • Fewer restrictive assumptions • Easier econometrics

27. Applications to Water Resources

28. Applications to Water Resources (cont)

29. Conclusions • In many uses of water, markets directly reveal value • Policy distortions • Quality, in-situ, and public uses require indirect or non-market methods • Actual behavior → indirect & complex methods • Stated behavior → direct & transparent methods • Nonuse values -- only stated preferences