the basics: is water an economic good? fundamentals of
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Slide 1
Economics, Water Use, and the Environment © 2011
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Slide 2 Lessons 1 & 2
• The basics: Is water an economic good?
– Fundamentals of economic reasoning:
• Scarcity, Choice & Cost
• Incentives
Lessons 3, 4,& 5
• Water Issues and economic reasoning
– Institutions shape incentives
• Property rights
• Rule of law
Lessons 6 & 7
• Transfer: econ. of water to econ. of environmental issues
– Dealing with externalities: Gov’t & markets?
– Solutions are found at the marginEconomics, Water Use, and the Environment ©2011
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Slide 3
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Slide 4 Role Play: How Much Water Do You Need?
Parent of Triplets
Car Nut
Gardener
Busy Executive
Economics, Water Use, and the Environment ©2011
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Slide 5
Policy Would Your water
usage change ?
If so, How?
What substitutions
would you make?
How would this
policy change your
water bill?
New Water Policies
Role __________ Current Water Bill $10 - $25/month
The mayor asks
everyone to conserve
water.
The city changes
all water bills to a
flat $20 fee/mo.
The city changes all
water bills to a flat
$100 fee/mo.
You are billed $1
per 1000 gal. used
You are billed 1¢
per gallon used
Economics, Water Use, and the Environment ©2011
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Slide 6
When is a basketball a substitute for water?
When is a basketball a substitute for water?
Economics, Water Use, and the Environment ©2011
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Slide 7
When is coal a substitute for water?
When is safflower a substitute for water?
When is a broom a substitute for water?
Economics, Water Use, and the Environment ©2011
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Slide 8
Unit Goals:
demonstrate the power of the economic way of thinking in
the context of environmental studies
elevate the level of discourse on the environment from
accusation to analysis, from sin to issue
Economics, Water Use and the Environment
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Slide 9
Is Water an Economic Good?
• Is Water Scarce ?
• Does people’s use of water reflect
rational choice?
• Does people’s use of water
respond to incentives ?
Economics, Water Use, and the Environment ©2011
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Slide 10
Economics, Water Use, and the Environment ©2011
Scarcity:
limited resources to satisfy unlimited wants and
needs forces choice
choice is necessary and imposes opportunity
costs
Rational Choice:
People choose the alternative THEY believe
offers the greatest benefits over costs
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Slide 11
Economics, Water Use, and the Environment ©2011FTE
Incentives:
rewards or punishments for behavior
Positive
Negative
Perverse
may be monetary, but frequently are not
price IS an extremely strong incentive
changing incentives changes behavior in
predictable ways
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Slide 12 Review
Economics, Water Use, and the Environment ©2011
Water IS an economic good:
– It’s scarce
• it has multiple uses, and one use entails giving up another (opportunity cost)
– people’s use of water responds to incentives
• price is an extremely powerful incentive for people to find and use substitutes for water
How much water do you “NEED” ?
– It depends:
• on the circumstances
• on personal interests, tastes, and values
• On the price of water
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Slide 13
Economics, Water Use, and the Environment ©2011
Why Would Anyone DO That?
QUIZ:
• A farmer in central California grows rice. Rice is grown in flooded paddies.
• (Central California is a desert!)
• The water the farmer uses to flood the paddies is delivered by a huge, expensive irrigation and canal system.
• Typical crop irrigation is less than 50% efficient. Rice growing in California is far less efficient than “typical” U.S. agricultural irrigation.
• Other crops, requiring much less water, could be grown in central California.
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Slide 14
Economics, Water Use, and the Environment ©2011
Categorize the following statements as:
Likely to be TRUE
We don’t know
• The farmer’s father grew rice and that’s all he knows how to do.
• The farmer isn’t very smart.
• The farmer is likely to agree to change crops when approached by
protestors from the “Keep Our Canals Full” committee.
• The farmer is worried about getting enough water to flood the fields.
• The farmer is a wasteful person.
• The farmer grew up near a lake and likes having water around.
• The farmer makes more money growing and selling rice than he
pays for the water to grow it.
• If getting water to grow rice became more expensive, the farmer
would be more likely to consider doing something different to make
a living.
What do we know about the farmer?
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Slide 15
Economics, Water Use, and the Environment 2011
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Slide 16
Economics, Water Use, and the Environment © 2011
Property RightsKey to Avoiding Environmental Conflict
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Slide 17
• Property Rights are human rights to resources that enable owners to
– use
– transfer
– exclude others from access
Economics, Water Use, and the Environment © 2011
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Slide 18 Property Rights . . .
. . .are established by formal and informal rules
about the privileges and limitations on the
ownership, use, and transfer of goods and
resources.
• These rights are specified in statue, ordinance,
other legislation, court decisions (common law),
tradition, and custom
Economics, Water Use, and the Environment © 2011
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Slide 19
Sort: What are the rules governing the privileges and limitations of
ownership, use, and transfer?
How “Ownership” Differs
idea
air
view
water
Air in
here
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Slide 20
Economics, Water Use, and the Environment ©2011FTE
well-defined
exclusive
transferable
enforceable
Characteristics of Full Property Rights
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Slide 21 Well-defined
?
Exclusive
?
Transferable
?
Enforceable
?
Skateboard
Playground ball
Water park or ski
lift ticket
Gun
Library book
Hamburger
Bottled water
Water in a
stream
Yes Yes Yes Yes
???
Yes
Yes
Some-
times
NO
Economics, Water Use, and the Environment © 2011
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Slide 22
BREAK . . .
BUT First
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Slide 23 M&Ms Activity
Rules:
1. “Claim” any number of M&Ms by writing the
number on your sticky note.
2. You will receive the number of M&Ms you claim IF
the total claims do not exceed the number in the
bag.
3. If the claims do NOT exceed the # in the bag, the
following prizes will be awarded:
• $20 for the biggest claim
• $15 for the 2nd biggest claim
• $10 for the 3rd biggest claim
Economics, Water Use, and the Environment ©2011
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Slide 24
Economics, Water Use, and the Environment © 2011
InstitutionsThe ‘rules of the game’ shape
incentives and behavior
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Slide 25 United States (surface) water law
Riparian (roots in English common law)
Typical in the East
People who own land along streams, lakes, springs, etc., have a right to “reasonable use” of the water.
Historical use protected by (common) law from new uses
Economics, Water Use, and the Environment ©2011
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Slide 26 United States (surface) water law
Prior appropriation (first-in-time, first-in-right)
Typical in the West - spontaneous response to conditions)
The first person to divert water (take it out of the stream) and use it, has the first right.
People who come after may claim water that is left after the first user has fulfilled his right.
“Ownership” of water rests with the state
Water right is a use right only, and is measured in cubic feet/second (C) or acre-feet (MT)
Economics, Water Use, and the Environment ©2011
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Slide 27 United States (ground) water law
• Origins again in English common law
• Variations state by state, but common themes
– Most often tied to land above
– Extraction for beneficial use
– Sometimes limited to “reasonable” use
– Extraction by one raises extraction costs of others
– “Ownership” achieved only via extraction (rule of capture)
Economics, Water Use, and the Environment ©2011
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Slide 28 Water is scarce – and becoming more so
• Use-It-or-Lose-It (Forfeiture)
• Salvaged Water Rule
• Beneficial Use
• Public Interest
Economics, Water Use, and the Environment ©2011
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Slide 29 Property rights issues
• Limited transferability
– Sharply hampers environmental protection
– Stops H2O from going to most productive use
• Limited exclusion with groundwater
– Yields race to extract
– Overuse/early use of water
– Later, higher-valued uses ignored
Economics, Water Use, and the Environment ©2011
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Slide 30
Gold Miners
Abe and Bob are gold miners. Abe sets up his camp on a stream,
builds a sluice, and diverts water at 10 cfs (cubic feet per second)
through the sluice. Bob arrives one month later and builds his camp
upstream from Abe. His sluice uses 5 cfs of water.
• What if water rights are riparian? prior appropriation?
Economics, Water Use, and the Environment ©2011
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Slide 31
Farmers
Anna is Abe's granddaughter. The family has expanded its holdings from
Abe's original claim along the stream to include 640 acres of cropland. Anna
grows alfalfa in her irrigated fields, and she could grow hay without irrigation.
Connie lives downstream and grows hay, but she wants to experiment with
vegetable crops. Vegetables require more water than is left in the stream
below Anna's farm.
1. What if water rights are prior appropriation and use-it-or-lose-it?
2. How would a salvaged water law affect the situation?
Economics, Water Use, and the Environment ©2011
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Slide 32
.
1. What if the use-it-or-lose-it rule is in effect?
2. What if the salvaged water rule is in effect?
3. What if neither the use-it-or-lose-it or
salvaged water rules are in effect?
Conservation
Unable to buy water from Anna, Connie sells most of her land and
experiments with a few vegetable beds. Connie's son Cameron tells
Connie that she could use one third less water if she would let him install
a drip irrigation system.
Economics, Water Use, and the Environment ©2011
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Slide 33
Environmental Amenities
A local environmental group is concerned because in dry years the stream
is so low that fish die by the thousands. They want both Connie and Anna
to leave more water in the stream. Suppose that the state has eliminated
its use-it-or-lose-it and salvaged water laws but defines "beneficial uses"
as mining, commercial, irrigation, electricity generation, and household.
1. What is the likely relationship between Connie and Anna and
the environmentalists?
2. How might the relationship change if the state adds
“conservation and recreation” to the list of beneficial uses?Economics, Water Use, and the Environment ©2011
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Slide 34 Ground WaterConnie's cousin David lives in a different part of
the country. While most of his neighbors are
farmers, he has no fond memories of his
childhood on the farm, so he started a bottled
water company, pumping water from a huge
underground aquifer to his bottling plant. His
neighbors irrigate from the aquifer, and the
nearby town draws its water from the same
source. Recent studies show that 5 percent
more water is being taken from the aquifer
each year than returns from rainwater and
other natural sources. The city council has
asked all users to cut back their water use by
10 percent, voluntarily.
Economics, Water Use, and the Environment ©2011
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Slide 35 1. If none of the rules on the chart is in effect—in other words, no
property rights to the water in the aquifer are defined—will David
abide by the voluntary cut-backs?
2. Suppose the city council puts a limit on the amount of water that can
be drawn from each well. What might David do?
3. Suppose a salesman offers to show David a way to reduce his use of
water by purchasing some new equipment for his plant. Is David likely
to buy? Explain.
4. Suppose the city council offers to sell David a portion of the aquifer.
What other property rights rules would encourage David to buy the
aquifer? What rules would discourage him from buying it?
5. Suppose David buys water rights to 15 percent of the aquifer. An
inventor offers to sell him a technology that will reduce his water
usage by 10 percent. What rules would encourage David to buy this
water-saving technology? What rules would discourage him from
buying it?
Ground Water
Economics, Water Use, and the Environment ©2011
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Slide 36 The Ruby River Mystery
• In May, 1987, a 1.5-mile stretch of the Ruby River in Montana virtually dried up. A
winter of little snow, a dry spring, and heavy demand for irrigation reduced the river
flow.
• Trout were stranded and eventually dried in pools that overheated.
• Meanwhile, farmers apparently had plenty of water; up to six inches of water stood
in fields along the river banks.
• The water necessary to save the trout was worth about $4,000. A large fishing and
conservation organization was willing to raise the money from its 50,000 members.
• But in spite of an outcry in the media and the expression of concern by anglers and
environmentalists, nothing was done and thousands of trout died.
Why did trout die when it would have cost so little to save them?
Economics, Water Use, and the Environment ©2011
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Slide 37 Clues:
• Under the rule of prior appropriation, the water rights clearly belong to the farmers.
• Three of the farmers with land along the Ruby River are avid anglers, but the rest are not.
• The conservation organization is NOT headquartered in Montana.
• Water law in Montana defined beneficial use in such a way that water must be diverted (taken from) the stream in order for the user to claim a right.
• There was a severe drought in the northern Rocky Mountain region in 1987-88.
• In the western U.S., the technology for agricultural irrigation is, on average, only about 50% efficient (meaning that up to 50% of the water diverted for irrigation never gets to the crops; it is lost to evaporation, leakage, etc.)
• Montana water law included a use-it-or-lose-it rule.
• Alfalfa, corn, and sugar beets are high water-use crops.Economics, Water Use, and the Environment ©2011
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Slide 38
Economics, Water Use, and the Environment 2011
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Slide 39 Scenario A small town lies at
the lower end of a
valley in which five
farmers raise some
market crops and hay
to feed their livestock.
The farmers, whose
families settled the
area in the 19th
century, irrigate their
fields with water from
a stream that flows
from the snowfields of
the mountains at the
head of the valley.
Most of the people in the town work for the farmers or supply goods and
services related to farming.
The exception is the Outfitter, a family-owned business that serves big game
hunters during the fall hunting season and bird hunters throughout the winter.
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Slide 40
Everything was great . . . untilEconomics, Water Use, and the Environment ©2011
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Slide 41 After a beautiful, dry winter
(which everybody loved –
not a single football game
was canceled at the high
school!), the river was low.
When the farmers opened
up the head gates to
irrigate their hay fields, the
river below town all but
dried up, and the water got
very warm. Soon, more
fish were floating belly-up
than swimming.
Economics, Water Use, and the Environment ©2011
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Slide 42 Word spread and fishermen
began to cancel their vacations.
The Outfitters were panicky; it
looked like they would lose most
of their yearly income!
And then they got mad. “The
farmers didn’t have to irrigate,”
they thought. “Their hay would
still grow.” True, they would only
get 2 cuttings instead of 3, but
that wouldn’t hurt them as much
as the low water was hurting the
Outfitters! It didn’t seem fair.
Economics, Water Use, and the Environment ©2011
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Slide 43 Town Meeting
Roles: You will be either a farmer or an outfitter. (It is up to you
whether or not to share the information on your role card.)
•The challenge to your group is to solve the problem that is threatening
to disrupt your community.
•If you come up with a solution that I cannot improve upon, you get to
keep the prize I’ve put on your table. If I can improve on your solution,
your group forfeits the prize.
•The problem is immediate – now, this summer, here, in this town!
Don’t waste time with pie-in-the-sky solutions to fix the world for all
time.
Economics, Water Use, and the Environment ©2011
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Slide 44
“Rules of the Game”
• The farmers have the water rights under prior appropriation.
• There is NO use-or-lose it provision in the law.
• There is NO salvaged water provision in the law.
• Beneficial uses include: diversion for agriculture, industrial, mining, and domestic water supplies; and in-stream use for recreation and conservation
(See handout)
Economics, Water Use, and the Environment ©2011
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Slide 45 A “Better” Solution Is One That:
• Makes the farmers better off without hurting the fishermen
• Makes the fishermen better off without hurting the farmers, or
• Makes both the farmers and the fishermen better off
Economics, Water Use, and the Environment ©2011
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Slide 46 Farmers
$75,000
HIGH
Water
yrs.
Outfitters
$100,000
WATER Farmers
$75,000
Farmers
irrigate
Outfitters
$20,000
LOW
Water
yrs.
Farmers
$50,000
irrigate
Outfitters
$100,000
The range of possibilities
Farmers DON’T
Economics, Water Use, and the Environment ©2011
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Slide 47
WATER Farmers
$75,000
Farmers
irrigate
Outfitters
$20,000
LOW
Water
yrs.
$50,000
irrigate
Outfitters
$100,000
The Range of Mutually Beneficial Solutions
$25,000difference
$80,000difference
Farmers DON’T
Economics, Water Use, and the Environment ©2011
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Slide 48 Relying on property rights & the market
• Advantages include
– Reduce wasteful use of resource (air, water, view)
– Encourage “production” of more amenities
– Create information about values and costs of environmental amenities
– Ensure allocation to highest valued use
• Some problems cannot (yet) be solved by markets, e.g., large scale climate change
• But emerging markets for water, fisheries, and air pollution demonstrate huge potential gains.
Economics, Water Use, and the Environment ©2011
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Slide 49 New Demand: In-stream Flows
Economics, Water Use, and the Environment ©2011
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Slide 50
Economics, Water Use, and the Environment 2011
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Slide 51 M&Ms Activity
Rules:
1. “Claim” any number of M&Ms by writing the
number on your sticky note.
2. You will receive the number of M&Ms you claim IF
the total claims do not exceed the number in the
bag.
3. If the claims do NOT exceed the # in the bag, the
following prizes will be awarded:
• $20 for the biggest claim
• $15 for the 2nd biggest claim
• $10 for the 3rd biggest claim
Economics, Water Use, and the Environment ©2011
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Slide 52 M&Ms Activity
Questions:
1. What was your thinking in making your “claim”?
2. Why did the total claim exceed the number of “fish”?
3. What incentives are created by the “rule of capture”?
4. Suppose the fishermen know that the fish stock is
declining and the fishery will collapse. How will they
change their behavior?
5. What is the cost of conserving?
6. How could we change the rules of the game to provide
incentives for conservation?Economics, Water Use, and the Environment ©2011
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Slide 53 “Tragedy of Commons”
• Common property resource will be over-exploited
because:
– Incentive for individual to capture value before someone
else does
– Individual can’t prevent others from capturing value
• Attempts to mitigate tragedy of the commons will impose
different costs and confer different benefits on individuals
and groups
Garrett Hardin, ecologist, 1969
Economics, Water Use, and the Environment ©2011
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Slide 54
http://vimeo.com/23564293Economics, Water Use, and the Environment ©2011
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Slide 55 the not-always-tragic commons
Economics, Water Use, and the Environment 2011
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Slide 56
Western Water Law
A Very Short Course
June 15, 2011
Bozeman Montana
Laura Ziemer, Director
Trout Unlimited’s
Montana Water Project
Bear Creek -
Above Irrigation
DiversionEconomics, Water Use, and the Environment ©2011
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Slide 57
Bear Creek - Below Irrigation DiversionEconomics, Water Use, and the Environment ©2011
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Slide 58
Economics, Water Use, and the Environment ©2011
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Slide 59
Economics, Water Use, and the Environment ©2011
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Slide 60
Economics, Water Use, and the Environment ©2011
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Slide 61
Economics, Water Use, and the Environment ©2011
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Slide 62
Economics, Water Use, and the Environment ©2011
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Slide 63 The Pearl River – Water In or Water Out?•Five farmers live along the upper reaches of the Pearl
River in the Oyster Valley.
•Each uses 10 acre feet of water, annually, for
irrigation. No flow is returned to the river.
•Water is appropriated under the prior appropriations
doctrine.
•Each farmer grows a variety of different crops under
different production methods. Assume that farmers
have no costs and no revenue if they cannot divert
water to irrigate.
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Slide 64 Farmer Adams Brown Chavez Jones Smith
Water Right
(10AF)
Established
1800 1810 1820 1830 1840
Irrigation
Value of
10AF water
$40,000 $10,000 $20,000 $30,000 $50,000
Water Rights to 10AF - Year Established
Year 1980 1982 1984 1986 1988 1990water
flow (AF)70 50 40 30 20 10
Oyster River – Annual Flow, Selected Years (Acre-Feet, AF)
•Assume that each farmer’s goal is to maximize his income.
Economics, Water Use, and the Environment ©2011
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Slide 65 year
annual
AF
Farmer
Adams
1800
Farmer
Brown
1810
Farmer
Chavez
1820
Farmer
Jones
1830
Farmer
Smith
1840
Total
Farmer
Use
Lower
Reach
Flow
Total
Farm
Revenue
1980
70
water
allocation
annual
revenue
1982
50
water
allocation
annual
revenue
1984
40
water
allocation
annual
revenue
1986
30
water
allocation
annual
revenue
1988
20
water
allocation
annual
revenue
1990
10
water
allocation
annual
revenue
Water Allocation by Seniority
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Slide 66 year Farmer
Adams
1800
Farmer
Brown
1810
Farmer
Chavez
1820
Farmer
Jones
1830
Farmer
Smith
1840
Total
Farmer
Use
Lower
Reach
Flow
Total
Farm
Revenue
1980
70
water
allocation 10 10 10 10 10 50 20 $150,000
annual
revenue 40,000 10,000 20,000 30,000 50,000
1982
50
water
allocation10 10 10 10 10 50 0 $150,000
annual
revenue40,000 10,000 20,000 30,000 50,000
1984
40
water
allocation10 10 10 10 0 40 0 $100,000
annual
revenue40,000 10,000 20,000 30,000 0
1986
30
water
allocation10 10 10 0 0 30 0 $70,000
annual
revenue40,000 10,000 20,000 0 0
1988
20
water
allocation10 10 0 0 0 20 0 $50,000
annual
revenue40,000 10,000 0 0 0
1990
10
water
allocation10 0 0 0 0 10 0 $40,000
annual
revenue40,000 0 0 0 0
Water Allocation by Seniority
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23
Slide 67
• Is the outcome of prior appropriation fair?
• Is the outcome of prior appropriation desirable?
• Are there other methods of allocation that you
think would produce “better” (fairer, more
desirable??) outcomes?
• Why aren’t the other methods in use?
– (Hint: What are the current “rules of the game”?)
Economics, Water Use, and the Environment 2011
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Slide 68 year
annual
AF
Farmer
Adams
1810
Farmer
Brown
1820
Farmer
Chavez
1830
Farmer
Jones
1800
Farmer
Smith
1840
Total
Farmer
Use
Lower
Reach
Flow
Total
Farm
Revenue
1980
70
water
allocation
10 10 10 10 10
50 20 $150,000
annual
revenue
$40,000 $10,000 $20,000 $30,000 $50,000
1982
50
water
allocation
10 10 10 10 10
50 0 $150,000
annual
revenue
$40,000 $10,000 $20,000 $30,000 $50,000
1984
40
water
allocation
annual
revenue
1986
30
water
allocation
annual
revenue
1988
20
water
allocation
annual
revenue
1990
10
water
allocation
annual
revenue
Water Allocation by Market (Assume Least-Cost Trade)
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Slide 69
1. What is your water worth to you? ________
2. What would it be worth to other farmers to have your
water? (Hint: Does it matter what year it is?)
• Farmer Adams ___: $__________
• Farmer Brown ___: $__________
• Farmer Chavez ___: $__________
• Farmer Jones ___: $__________
• Farmer Smith ___: $__________
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24
Slide 70 year
water
Farmer
Adams
1800
Farmer
Brown
1810
Farmer
Chavez
1820
Farmer
Jones
1830
Farmer
Smith
1840
Total
Farmer
Use
Lower
Reach
Flow
Total Farm
Revenue
1982
50
water
allocation10 10 10 10 10 50 0 $150,000
annual
revenue$40,000 $10,000 $20,000 $30,000 $50,000
1984
40
water
allocation10 10 0 10 10 0 10 40 0 $100,000
annual
revenue
BEFORE
trade
$40,000 $10,000
0
$20,000 $30,000 0
50,000
low cost
trade$10,000 -$10,000 $140,000
annual
revenue
AFTER
trade
$40,000 $10,000 $20,000 $30,000 $40,000
1986
30
water
allocation10 10 10 0 0 30 0 $70,000
annual
revenue
BEFORE
trade
$40,000 $10,000 $20,000 0 0
low cost
trade(s)
annual
revenue
AFTER
trade
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Slide 71
“Rules of the Game”
• The farmers have the water rights under prior appropriation.
• There is NO use-or-lose it provision in the law.
• There is NO salvaged water provision in the law.
• Beneficial uses include: diversion for agriculture, industrial, mining, and domestic water supplies
Economics, Water Use, and the Environment ©2011
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Slide 72 A “Better” Solution Is One That:
• Makes some farmers better off without hurting the other farmers
• Makes all the farmers better off
Economics, Water Use, and the Environment ©2011
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25
Slide 73 year
water
Farmer
Adams
1800
Farmer
Brown
1810
Farmer
Chavez
1820
Farmer
Jones
1830
Farmer
Smith
1840
Total
Farmer
Use
Lower
Reach
Flow
Total Farm
Revenue
1982
50
water
allocation10 10 10 10 10 50 0 $150,000
annual
revenue$40,000 $10,000 $20,000 $30,000 $50,000
1984
40
water
allocation10 10 0 10 10 0 10 40 0 $100,000
annual
revenue
BEFORE
trade
$40,000 $10,000
0
$20,000 $30,000 0
50,000
low cost
trade$10,000 -$10,000 $140,000
annual
revenue
AFTER
trade
$40,000 $10,000 $20,000 $30,000 $40,000
1986
30
water
allocation10 10 0 10 0 0 10 0 10 30 0 $70,000
annual
revenue
BEFORE
trade
$40,000 $10,000
0
$20,000
0
0
30,000
0
50,000
low cost
trade(s)$10,000
20,000 $20,000
-$10,000 $120,000
annual
AFTER
trade
$40,000 $10,000 $20,000 $10,000 $40,000
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Slide 74 year
water
Farmer
Adams
1800
Farmer
Brown
1810
Farmer
Chavez
1820
Farmer
Jones
1830
Farmer
Smith
1840
Total
Farmer
Use
Lower
Reach
Flow
Total
Farm
Revenue
1986
30
water
allocation
10 10 10 0 0 30 0 $70,000
annual
revenue
BEFORE
trade
$40,000 $10,000 $20,000 0
$30,000
0
$50,000
trade(s) +10,000 +20,000 -$20,000 -$10,000 $120,000
annual
revenue
AFTER
trade
$40,000 $10,000 $20,000 $10,000 $40,000
1988
20
water
allocation
10 10 0 0 0 20 0 $50,000
annual
revenue
BEFORE
trade
$40,000 $10,000 0 $0 0 $50,000
trade(s) ??????? +$10,000 ??????? -$10,000 $90,000 ??
annual
revenue
AFTER
trade
$40,000 $10,000 0 $?????? $40,000
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Slide 75 New players in the game
Environmentalists Recreational users
Economics, Water Use, and the Environment ©2011
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26
Slide 76
“Rules of the Game”
• The farmers have the water rights under prior appropriation.
• There is NO use-or-lose it provision in the law.
• There is NO salvaged water provision in the law.
• Beneficial uses include: diversion for agriculture, industrial, mining, and domestic water supplies; and in-stream use for recreation and conservation
Economics, Water Use, and the Environment ©2011
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Slide 77 A “Better” Solution Is One That:
• Makes any farmers or non- farmers better off without hurting the others
• Makes both farmers and non-farmers better off
Economics, Water Use, and the Environment ©2011
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Slide 78 year
water
Farmer
Adams
1800
Farmer
Brown
1810
Farmer
Chavez
1820
Farmer
Jones
1830
Farmer
Smith
1840
Total
Farmer
Use
Lower
Reach
Flow
Total
Farm
Revenue
water
allocation
0
annual
revenue
BEFORE
trade
trade(s)
annual
revenue
AFTER
trade
Seller Buyer Price
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27
Slide 79
Economics, Water Use, and the Environment ©2011
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Slide 80
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Slide 81
Economics, Water Use, and the Environment © 2011
Property RightsPollution & the Power of Marginal
Analysis
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28
Slide 82 Water: Who Owns It?
Economics, Water Use, and the Environment ©2011
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Slide 83
• Markets usually allocate resources to their “best” uses.
– “Best” is the use with the greatest excess of benefits over costs.
• But sometimes, they don’t.
– A.C. Pigou called these instances“market failure.”
• The Economics of Welfare (1920): market failure occurs when all the benefits or costs of an exchange are not captured in the exchange.
– Ronald Coase - The Problem of Social Cost (1960)
• If property rights are well-defined, enforced and transferable, the affected parties will reach a mutually agreeable outcome
• The presence of “externalities” must reflect a failure to define, enforce, or permit transfer of property rights.
Externalities:
Market Failure or Property Rights Problem?
Economics, Water Use, and the Environment © 2011
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Slide 84
Economics, Water Use, and the Environment ©2011FTE
Negative Externalities
Costs of producing & consuming that spill over onto people who don’t receive the benefits.
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29
Slide 85
Economics, Water Use, and the Environment ©2011FTE
Positive Externalities
Benefits of producing & consuming that spill over onto people who don’t bear the costs.
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Slide 86
Economics, Water Use, and the Environment ©2011FTE
Marginal AnalysisMargin = Additional or Next
• Marginal cost = the cost of the next unit of production
• Marginal benefit = the benefit received from the next unit of production
Propositions:
• Real life is an exercise in marginal thinking. We rarely make “all-or-nothing” decisions.
• We tend to forget marginal analysis in public discourse.
• Pollution is NOT and all-or-nothing problem
– How much is the next unit of cleanliness worth to us?
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Slide 87
Economics, Water Use, and the Environment ©2011FTE
Pollution Clean-Up Problems
Background concepts:
• Externality: pollution is a negative externality. It’s difficult to clean up when property rights are unclear. Once property rights are clear, then the question for the owner of those rights is: “How clean is clean enough?”
• “No pollution” isn’t an acceptable or realistic answer. – Pollution is the result of production
– There’s a cost to NOT polluting
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30
Slide 88
Economics, Water Use, and the Environment ©2011FTE
Activity: Would YOU Swim There?
• The pond belongs to the Homeowners Association.
• Homeowners Association members will bear the cost and reap the benefits of any clean-up of the pond.
• Every family in the community pays homeowners association dues. Dues are charged per lot, and are not dependent upon the size and location of the lot, nor the value of the home.
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Slide 89
Economics, Water Use, and the Environment ©2011
Bid Stage 1: Improving the ViewCost: $1 million:
• Remove the junk – vehicles, construction debris, leaking barrels, etc.
• Replace the fence with better and more attractive barrier
• Restrict access to shoreline to entice birds and other wildlife
Anticipated benefits:
• Lower insurance for homeowners association (est. -$500,000)
• Increased property values in entire community by $2.5 to $3 million
• Increase recreational and aesthetic values by about $10,000 - $20,000
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Slide 90
Economics, Water Use, and the Environment ©2011FTE
Stage 5: Clean Enough to Drink
Additional cost over stage 4: $1 million
• Install filtration system
• Install pump
Additional benefits: (notice that these are marginal benefits – in addition to . . . )
• Reduced dependence on city water supply and potential rebate from city of $50,000 - $150,000
• Increased property values in entire community by $0 -$.25 million
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31
Slide 91
Project
stage
% pollution
removed
Total
cost
(in $)
Results: Possible Uses $ Estimate of
Total Benefits
1 40% $1 m Walking, picnics, wildlife
viewing, dog run
$3-4 m
($3.5 m. avg.)
2 65% $2 m Skating, hockey, boating $5-6 m
3 80% $3 m Fishing and ice fishing,
greenbelt irrigation, garden
irrigation
$6-7 m
4 90% $4 m Swimming $7-7.5 m
5 95% $5 m Drinking water $7.25 - $7.5 m
Total Cost = $ 5 million Total Benefit = approx. $7.5 million
Bid for complete clean-up:
Economics, Water Use, and the Environment ©2011
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Slide 92
Economics, Water Use, and the Environment ©2011FTE
Interest Groups
• Homeowners Association Board
• The Fish
• TP2― (Tired of Teen-Agers Tee-Peeing)
• Boosters
• PPP – Pond Perimeter Property Owners
• KPK ― (Keep Our Property Kleen)
• Out-of-Sight, Out-of-Mind
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Slide 93
Economics, Water Use, and the Environment ©2011
Discussion Questions
(remember your role)
For each proposed level of the project:
1. How much additional cost does the community pay for each level of clean-up?
• Who bears this additional cost? (do you ?)
2. How much additional benefit does the community gain by paying for this level of clean-up? (Look both at the $ amount of the benefits AND check the project description to see what the benefits actually are.)
• Who gets the benefit? (Do you? How much?)
3. Is your group willing to support this level of cost in return for this benefit? Why or why not?
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32
Slide 94
Economics, Water Use, and the Environment ©2011FTE
Marginal Analysis
Project
stage
%
pollution
removed
Additional
Pollution
removed
Total
cost
(in $)
Marginal
Cost
$
Estimate
of
Total
Benefits
Marginal
Benefit
1 40% 40% $1 m $1 m $3-4 m $3.5 m
2 65% $2 m $5-6 m
3 80% $3 m $6-7 m
4 90% $4 m $7-7.5 m
5 95% $5 m $7.25-
$7.5 m
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Slide 95 Marginal Analysis
Economics, Water Use, and the Environment ©2011
Project
stage
% pollution
removed
Additional
pollution
removed
Total cost
(in $)
Marginal
Cost
$Estimate
of
Total
Benefits
Marginal
Benefit
1 40% 40% $1 m $1 m $3-4 m $3.5 m
2 65% 25% $2 m $1 m $5-6 m $2 m
3 80% 15% $3 m $1 m $6-7 m $1 m
4 90% 10% $4 m $1 m $7-7.5
m
$.75 m
5 95% 5% $5 m $1 m $7.25 -
$7.5 m
$.25 m
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Slide 96 How do we
prevent
externalities?
Institutions matter: Property Rights are the rules of the game
Role for government:
1. Clearly define property rights
2. Enforce property rights and secure them through the common law
• private tort law in which those who inflict harm on others must
stop and make whole
3. Create an enabling legal framework in which property rights are
exchangeable
(government failure ????)
Economics, Water Use, and the Environment ©2011
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33
Slide 97
It’s not the people; it’s the system.
Unit Goals:
demonstrate the power of the economic way of thinking in
the context of environmental studies
elevate the level of discourse on the environment from
accusation to analysis, from sin to issue
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