Rent, Land, Water, and Common Property

How is value determined for natural resources? Prices?

Example: Grape Prices & Oaks

High grape prices in 2000 caused conversion of oak woodland to grape production. Why?Who gains or loses from a increase or decrease in grape prices?What are the consequences for oaks of price change in grapes?

Concepts of “rent”Contract rent: payment by tenant for right to use owner’s property—not the concept of rent we use here

ApartmentEconomic rent: payment to a fixed factor above competitive rate of return (payment for a good in excess of its cost of provision)

Fertile agricultural land (costs nothing to provide)Scarcity rent: premium accruing to a factor of production because it is limited in supply

Willie NelsonWell-known professors (why is Henry Yang paid so much?)Exhaustible resources (like gold)

Quasi-rent: Short-run profits that are competed away over time.

New Nat’l Forest policy increases logging—temporarily benefits current loggers

What determines the value of land?

Land values have two components“Return” from productive activities (like growing grapes) -- rentSpeculative component – discounted value of expected use in the future• Eg, may expect demand for housing in 50

years

Take a closer look at rent and return

Example: “Return” to Ag LandHave 1000 acres of land, best used for growing strawberries

Bushels of Strawberries

Marg Cost

Price of Strawberries

Return to Land = RL

Return to land is rent – surplus accruing to factors in short supply

Demand

Supply

What determines the price of ag land?Assume no speculative componentPrice of land: PL

Annual returns to land: RL

Interest rate on similar assets: iArbitrage condition: iPL = RL PL=RL/iIn other words

Typical returns to assets must equal incomeland value is net present value of future returns

Example: an acre generates $100 of returnAssume 5% interest/discount rateLand price = 100/0.05=$2,000

Back to original example of grapesEffect of price change on oaks

3 different farms (types of land)-A, B, C1000 acres of each typeWith $1000 in inputs can produce

A: 500 bushels [cost = $2.00/bushel]B: 400 bushels [cost = $2.50/bushel]C: 250 bushels [cost = $4.00/bushel]

Current price $2.00/bushel

Who gains from 2x price increase?

500 900 1150 Bushels

$/bushel

2.00

2.50

4.00

RentC=0

Farm A: gains $1000Farm B: gains $600Farm C: break evenOaks (on B&C): lose

RentB=600

RentA=1000

What is the rent at the oldPrice of $2 a bushel?

Old Price

New Price

Observe:

All grapes sell at the same priceBetter land fetches higher rentsMarginal land fetches littleInframarginal lands garner “Ricardian Rents”QUESTION: If price drops, what farmer goes out of business? Value of loss?

Value of land for housing1. Returns to land for housing (per year)

Acres

$/acre

Demand for housing

Supply of land

Price perYear

2. Value of asset – one acre of land =Net Present Value of Stream of Returns from housing

(May well increase over time.) ORReturns today plus discounted expected value tomorrow.

Summary for land

Land is in limited supply, of different levels of quality and in different locations (some more convenient than others)Land value consists of

NPV of stream of returns (e.g., strawberries or housing services)

May contain speculative component due to future value

The economics of water

Allocation: balance between many users and limited resource:

Consumptive uses (residential, industrial, agricultural)Non-consumptive uses (fisheries, recreational, hydro-electric power, transportation)

Water pricesTypically depend on userTypically average cost priced (as opposed to marginal cost priced)

Consumptive users in US

Irrigation: 39%Thermo-electric power: 39%Public supply: 12%Industry: 6%Livestock: 1%Home: 1%Mining: 1%Commercial: 1%

Top 3 agricultural users

State Acres (‘000)

% flood % spray

% drip

California

9,480 74% 19% 7%

Nebraska

7,450 47% 53% 0%

Texas 6,310 56% 43% 1%

Agricultural vs. municipal

Agricultural water heavily subsidizedPrice ~ $20/AF, use 80% water in CaliforniaMarginal cost to supply ~ $1000/AF

Municipal waterPrice > $300/AF

GroundwaterLargely unregulated, “open access” resource, few property rights, difficult to enforce pumping laws

Inefficiencies in water supply & implications

Rents go to inframarginal sources

Quantity of Water

State Water

Lake Cachuma Demand A

Demand B

Rent,Demand A

PA

PB

Price is associated with marginal source

Marg Cost

Average Cost Pricing – inefficientGovernment agencies and regulated monopolists often required to price to yield zero profitsPrice = (Total costs)/quantityWith Avg Cost Pricing, state water (too much consumption)With efficient pricing, no state water

Quantity of Water

State Water

Lake CachumaDemand A

Average Costs

Marg Cost

Too much water

Examples

What happens when parking at UCSB is average cost priced?

Limited number of parking lot spacesExtra spaces can only be provided with parking garages

Hint: Marginal costs areLots: $100/space/yearParking Garages: $4000/space/year

What is efficient policy?

The Central Valley Project

The CVP carries water from Northern CA to southern CA. Water rights for CVP water follow the land that gets the water, not the owner (ie, not severable).

Which landowners gain from CVP?

Who gains from CVP?

Landowners that purchased property prior to CVP gain.Prior purchase price of land did not “capitalize” the CVP water right.Future price will capitalize that right.Rent accrues to property that will obtain rights to CVP water.

Imperial Valley/San Diego

High profile water transfer proposed from Imperial Valley to San DiegoImperial Valley

Desert, agricultural, poorest county in CAVast water rights

San DiegoOne of richest, largely municipal, high marginal value for water.

The economics of water transfer

What does economics have to say about water transfer from agricultural uses to municipal uses?Allocate a fixed amount of water between the 2 uses.How do we know when allocation is efficient?

Equi-marginal principle

Efficient allocation

0% 100%0%100%

DU

DA

U:A:

$ (U) $ (A)San Diego willingto pay this for 1st AF

U0

A0

Imp. Valley willingto sell 1st AF for this

$1000

$50

Did they reach agreement?

Different marginal values should lead to large incentives for tradeImperial Valley was going to sell about 5% of water allocation to San Diego at price of around $300/AF.Deal broke down initially (2002)

Concerns over agricultural labor & way of life

Feds intervened by cutting back IV waterDeal struck in Fall, 2003

California & the Colorado R.

7 states draw from Colorado:Arizona, Colorado, California, New Mexico, Utah, Wyoming, and Nevada

Dept. of Interior: CA has not lived up to sharing & conservation obligations

Saw Imperial Valley transfer as good thingIf no deal, slash CA entitlement from 5.2 MAF/yr to 4.4 MAF/yr.Jan 1, entitlement reduced.

Allocation by prior appropriation

Prior Appropriations: “First in time, first in use” Economists criticize open access systems because they lack specified property rights. “Prior appropriations” gives property rights to agricultural users. Is this an efficient way to allocate water between 2 consumptive users?

“Prior appropriations”

Supply

Urban Supply(S-QA)

Water

Price

QAg

PAg

PUrb

DUrb DAgDTotal

Q*

P*

Ag users get first dibs, consume QAg units of waterat price PAa. Urban buys QUrb

at price PUrb. PAa< PUrb so equi-marginal principle fails.

QUrb