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Introduction to Economics of Water Resources. Public or private. Excludability (E): the degree to which users can be excluded Subtractability (S): the degree to which consumption by one user reduces the possibility for consumption by others. - PowerPoint PPT Presentation
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Introduction to Economics of Water
Resources
Public or private• Excludability (E): the degree to which users can be excluded• Subtractability (S): the degree to which consumption by one user
reduces the possibility for consumption by others.• Public goods: have a low subtractability and a low excludability• Private goods: have a high market potential because of their high
levels of excludability and subtractability
Basic Need, Merit, or Economic Good ?• Depending on the quantities supplied to individuals, water
can be a basic human need, merit good, or an ordinary economic good:– under conditions of extreme scarcity, there is only one option and
only one choice to be made, which is to get the water to the thirsty, which closes all options. In this case, water is no more an economic good but a basic need for people to survive
– When there is just enough for the thirsty, water also fulfils the criteria for being considered a merit good: good that has a high societal function but are generally not expressed in monetary terms, such as the importance of having clean rivers and a beautiful scenery.
– It is obligation of human societies to assure reasonable levels of water to meet the basic human needs and merit goods
Basic Need, Merit, or Economic Good ?
Some Economic Indicators
• NPV (net present value)
• Internal Rate of Return (IRR)Interest Rate where NPVcost=NPV benefits
• Economic EfficiencyMarginal Cost = Marginal Benefits
Some Economic Indicators• NPV
Strong:– Choosing among mutually exclusive projects– Decide if the project can be fundedWeak:– Sensitive to interest rate– No information about degree of acceptability
• Internal Rate of Return (IRR)Strong:– Maximize the return when we have Limited
fund – Used to rank projects– Decide if the project can be fundedWeak:– No information on the size of the project
tt
r
CBNPV
)1(
)(
)0)1(
)(@(
t
t
r
CBr
Costs / Benefits• Direct Cost / Benefit
– Easily measured, allocated to a specific production and consumption • Indirect Cost / Benefit
– Difficult to be measured, indirectly related to production and consumption
• Fixed Cost– Do not vary with the quantity of output (capital / investment costs)
• Variable Cost (is it same as recurrent cost ??)– Related to quantity (raw material, chemicals, labors, fuel, etc.)
• Incremental cost / benefit – Compare the situation with or without introducing new components to
a project
• Opportunity Cost– The cost of foregoing the opportunity to earn a return
Some Economic Indicators• B/C ratio
Strong:– Rank projects according to degree of
acceptability– Decide if the project can be fundedWeak:– Sensitive to interest rate
t
t
tt
ratio
r
Cr
B
BC
)1(
)1(
Economic EfficiencyTC
Q*
TB
MC
AC
MB
max
Quantity
TC
Q*
TB
MC
AC
MB
max
Quantity
PTC: Total Cost TB: Total Benefit MC: Marginal CostAC: Average Cost MB: Marginal Benefit
ITB connection
Economic Efficiency
TC
Q*
TB
MC
AC
MB
max
Quantity
TC
Q*
TB
MC
AC
MB
max
Quantity
P
Rising limb = supply curveBelow the falling part of ACHigher the rising part of ACAffected by variable costs
= Demand Curve= Benefits associated with One Unit increase in output
Optimality Condition
Definitions • Total cost curve: variation in total production cost (Fixed costs +
variable costs) with the level of production• Total benefit curve: variation in the resulting benefits with the
level of production• Average cost curve : total cost divided by the level of production
– U shape– Decrease first because of economies of scale
• Marginal cost curve: the slope of the total cost curve, represent the change in total cost associated with a unit increase in output– Supplier will not produce an extra unit unless the price exceeds the
marginal cost– The rising limb represent the supply curve
• Marginal benefit curve: the slope of the total benefit curve, represent the change in total benefit associated with a unit increase in output– Represent the demand curve
RESULTS: M&I Demand Curve
GAZA DOMESTIC & INDUSTRIAL WATER DEMAND CURVE
0.5
0.6
0.7
0.8
0.9
1
1.1
1.2
1.3
1.4
7 7.5 8 8.5 9
Monthly Demand (Mm3)
Un
it P
rice
($/m
3)
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
2 3 4 5 6 7 8 9 10 11 12
monthly supply (Mm3)
mar
gin
al c
ost
($/m
3)
import 1
brackish water treatment 1
import 2
brackish water treatment 2
seawater desalination 1
seawater desalination 2
RESULTS: M&I Supply Curve
RESULTS: 2010 Equilibrium Point
0.5
0.6
0.7
0.8
0.9
1
1.1
1.2
1.3
1.4
2 3 4 5 6 7 8 9 10 11
monthly supply / demand (Mm3)
mar
gin
al c
ost
/ p
rice
($/
m3)
supply
2010 demand
Cash Flow ExampleYear 1 2 3 4 5 6 7 8 9 10
Investment Cost 100000 50000 50000
O&M Cost 10000 10000 10000 10000 10000 10000 10000
Cost 100000 50000 50000 10000 10000 10000 10000 10000 10000 10000
NPVc 100000 45455 41322 7513 6830 6209 5645 5132 4665 4241 227012
Revenues 50000 50000 50000 50000 50000 50000 50000
NPVr 0 0 0 37566 34151 31046 28224 25658 23325 21205 201174
Interest rate 0.01 0.02 0.03 0.04 0.05 0.06 0.07 0.08 0.09 0.1
NPVc 264476 259285 254400 249797 245455 241353 237473 233799 230317 227012
NPVr 329781 311034 293632 277462 262421 248415 235361 223181 211807 201174
IRR
150000
175000
200000
225000
250000
275000
300000
325000
3500000
0.01
0.02
0.03
0.04
0.05
0.06
0.07
0.08
0.09 0.1
0.11
Interest Rate
NP
V NPVc
NPVr
IRR=0.068
Free Market System• Competitive system: Allocation of resources
with maximum efficiency– Consumers must be consistent and independent– Producers must operate with the goal of profit
maximization– No price regulations or constraints by the
government, labors, business, etc– Goods, services, and resources must be mobile
free to move from market to another– Buyers and sellers must be aware of the prices
instantaneously– Commodities must be sufficiently divisible – All resources must be fully employed
Market Demand• People will buy less at higher prices provided that
income, tastes, prices of substitutes remains constant• Price elasticity of the demand:
• Shifts in Demand:– Customer preferences– Number of customers– Customer income– Price of related goods– Availability of alternatives
Q
P
Market Demand• Price elasticity of the
demand:– More elastic at high prices– Rigid at low prices– Perfectly elastic when
E=infinity, means no one will buy if the price increases
• Example:– Calculate E at different
locations on the curve assuming a unit change in price will result in a unit change in the demand.
Q
P
1
531
5
3
E=-5
E=-1
E=-0.2
Market Supply• Market supply: the amount
that producers are willing to sell/produce at different prices
• Shifts in supply curve:– Technological advances– Favorable production
conditions– Lower input cost
Q
P
Market Equilibrium• Market equilibrium:
– the minimum that customer can pay for certain quantity and the maximum that suppliers can receive for the same quantity
– Automatic way for allocation
– Represent the customers willingness to pay
– Economic efficiency
Q
P Demandsupply
surplus
shortage
Irrigation Water Prices in Israel