The Economics of Water for Environmental Flows Mitchell Mathis Houston Advanced Research Center Presentation for the Science Advisory Committee to the Study Commission on Water for Environmental Flows June 18, 2004

Overview What is economics? What is economics? What is economic value? What is economic value? Economics and water Economics and water Economic value of environmental flows Economic value of environmental flows Economics and the allocation of water for environmental flows Economics and the allocation of water for environmental flows

What is Economics?

The study of scarcity, choices, and tradeoffs? The study of scarcity, choices, and tradeoffs? The study of production and consumption? The study of production and consumption? The study of markets? The study of markets? The study of how to use resources in a way that produces the most benefits? The study of how to use resources in a way that produces the most benefits? The study of human welfare? The study of human welfare?

What is Economics? Consumers Firms Individual economic behavior Markets The economy as a whole Macroeconomics Microeconomics Inflation GNP Interest rates Unemployment Federal Reserve

What is Economics? Positive: “What is” Positive: “What is” Normative: “What should be” Normative: “What should be” Objective: Utilize resources in a way that maximizes benefits “Efficiency”

What is economic value? Marginal Costs (Supply) Marginal Benefits (Demand) Quantity $ Quantity* Price* Consumer Surplus Producer Surplus

Economics and Water Water users Water users Water demand Water demand Water supply Water supply Allocation across competing uses Allocation across competing uses The importance of economic value The importance of economic value HumansWater MunicipalAgriculturalIndustrial Ecosystem

The Cost of Water subsidy marginal cost marginal benefits (demand) with infrastructure subsidy with infrastructure subsidy and no charge for raw water Price paid for water rarely reflects scarcity, economic value =>

Water Demand Relates quantity demanded to price paid Relates quantity demanded to price paid Demand reflects willingness to pay/marginal benefits (a source of economic value) Demand reflects willingness to pay/marginal benefits (a source of economic value) For many water uses marginal benefits (demand) are not well understood, especially environmental uses For many water uses marginal benefits (demand) are not well understood, especially environmental uses MunicipalAgriculturalIndustrialEnvironmental $ Q $ Q $ Q $ Q

Water Demand MunicipalAgriculturalIndustrialEnvironmental $ Q $ Q $ Q $ Q $ Q Total Demand Without demand for environmental flows supply

Decision-Making: Optimal Allocation MunicipalAgriculturalIndustrialEnvironmental $ Q $ Q $ Q $ Q Industrial Agricultural Municipal Industrial Agricultural Municipal Optimal Maximizes total benefits Sub-Optimal Does NOT maximize total benefits

Decision-Making: Weighing Cost and Benefits Net Benefits = Benefits - Costs Environmental Flows

Decision-Making: Weighing Cost and Benefits Net Benefits = Benefits - Costs Environmental Flows

Decision-Making: Weighing Cost and Benefits Net Benefits = Benefits - Costs Environmental Flows

Economic Value of Water ($ per acre-foot) UseAverageMedianMinimumMaximumNo. of Values Instream Recreation/Fish and Wildlife Recreation/Fish and Wildlife Habitat Maintenance Habitat Maintenance48502, Waste Disposal Waste Disposal Navigation Navigation Hydropower Hydropower Withdrawal Irrigation Irrigation754001, Industrial Processing Industrial Processing Domestic Domestic Source: Frederick (1997)

Water and Ecosystem Services Water sustains ecosystem Water sustains ecosystem Ecosystem provides valuable services Ecosystem provides valuable services As raw material and intermediate inputs to firms As raw material and intermediate inputs to firms Directly to consumers Directly to consumers Value of water derives from its contribution to the value of ecosystem services Value of water derives from its contribution to the value of ecosystem services HumansWater MunicipalAgriculturalIndustrial Ecosystem

Value of Environmental Flows in Production Instream Flows RecreationAesthetics Environment Use Values (indirectly through benefits of ecosystem services) Firms $$$ The Market Ecosystem Service Valuation Approach: Productivity Method (net factor income, derived value)

Value of Environmental Flows Instream Flows RecreationAesthetics Environment Use Values (indirectly through benefits of ecosystem services) Firms $$$ The Market Shrimp Value derived from : market price of shrimp production process of the firm relationship of water to shrimp

River Allocation Agriculture Communities Valley Economy Eco-tourism Environment Manufacturing WATER USE IN THE LOWER RIO GRANDE VALLEY Lower Rio Grande River What’s left over

Value of Environmental Flows Instream Flows RecreationAesthetics Environment Use Values (indirectly through benefits of ecosystem services) Consumers Habitat maintenance Waterfoul hunting Fishing Recreation and nature appreciation opportunities Other ecosystem services Valuation Approaches seek to estimated “willingness to pay” hedonic pricing travel cost contingent valuation

Value of Environmental Flows Instream Flows RecreationAesthetics Environment Non-use Values Consumers Valuation approach: Contingent Valuation

Water to Sustain the Ecosystem: A “Public Good”? What is a public good? What is a public good? Optimal provision and the “free rider” concern Optimal provision and the “free rider” concern Excludability Subtractability low high Private goods Public Good Open Access Resource Club Goods

Questions ?