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John B. Braden University of Illinois at Urbana-Champaign. Economic Modeling for Water Resources. NSF Interdisciplinary Modeling Workshop – July 2005. Thanks:. Laurel Saito Heather Segale Xiaolin Ren. Contributions of Economics. Understand Behaviors Responses to institutions & policies - PowerPoint PPT Presentation
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John B. Braden University of Illinois
at Urbana-Champaign
Economic Modeling for Water Resources
NSF Interdisciplinary Modeling Workshop – July 2005
NSF Interdisciplinary Modeling Workshop – July 2005
Thanks:
Laurel Saito Heather Segale Xiaolin Ren
NSF Interdisciplinary Modeling Workshop – July 2005
Contributions of Economics Understand Behaviors
– Responses to institutions & policies– Market power (size, information)– “Positive” analysis
Design Institutions & Policies– Benefit/cost analysis– Planning for behaviors– “Normative” analysis
NSF Interdisciplinary Modeling Workshop – July 2005
Limitations of Economics
Anthropocentric Utilitarian Statistical Allocational (efficiency) Material
NSF Interdisciplinary Modeling Workshop – July 2005
Economic Modeling
Theory – generate hypotheses
Econometrics – test hypotheses
Operations Research – simulate outcomes– optimize complex systems
NSF Interdisciplinary Modeling Workshop – July 2005
Outline of Presentation
1. Basic Economic Models2. Pricing Aquatic Ecosystems3. Hydro-Economic Models4. Bio-Economic Models5. Benefit-cost Analysis6. Risk and Uncertainty7. Summary Remarks
NSF Interdisciplinary Modeling Workshop – July 2005
Resources for Lecture
Griffin, R.C. Water Resource Economics. MIT Press (forthcoming)
Young, R.A. Determining the Economic Value of Water. Resources for the Future (2005)
Other books & articles on website
NSF Interdisciplinary Modeling Workshop – July 2005
1. Basic Economic Models
NSF Interdisciplinary Modeling Workshop – July 2005
Agent Models
Consumers Maximize Utility Max u(Y,w) , uy, uw > 0
uyy, uww < 0
s.t. PYY + pww < B
Producers Maximize ProfitMax π = p1y1 – Σi cixi – cww
s.t. y1 = f(X, w) , fx, fw > 0;
fxx, fww < 0
NSF Interdisciplinary Modeling Workshop – July 2005
Marginal Analysis
Marginal benefits = incremental demand price
Marginal costs = incremental supply price
Operating returns vs. fixed costs
NSF Interdisciplinary Modeling Workshop – July 2005
Supply Model – Input Choice
W
X
CSlope
C
01y
21y
11y
W
X
X
W
NSF Interdisciplinary Modeling Workshop – July 2005
Supply Model – Output
1P
1y 1y
1P1
1
( , )X W
CS C C
y
NSF Interdisciplinary Modeling Workshop – July 2005
Aggregate Supply
1y
1P
1pS 1
qS 1AggS
NSF Interdisciplinary Modeling Workshop – July 2005
Demand Model
1 11
( , , )D
d P P BP
1y
1P
NSF Interdisciplinary Modeling Workshop – July 2005
Aggregate Demand
1y
1P
1bd1
ad 1Aggd
NSF Interdisciplinary Modeling Workshop – July 2005
Nonrival (“Public”) Goods
Rival – Ordinary goods that only one person can consume
Nonrival – Goods that can be consumed by many simultaneously– Excluability allows pricing
NSF Interdisciplinary Modeling Workshop – July 2005
“ Public Goods” & Economic Value
azd
bzd Agg
zd
zP
z
NSF Interdisciplinary Modeling Workshop – July 2005
Markets
Producers offer good & buy inputs
Consumers bid for goods & supply labor
Prices coordinate producers & consumers– Output markets (py, pw)
– Input markets (ci, cw)
– Parametric to individuals
NSF Interdisciplinary Modeling Workshop – July 2005
Market Model
1y
1P1aggS
1aggd
1My
1MP
NSF Interdisciplinary Modeling Workshop – July 2005
Welfare Analysis (normative)
Maximize Net Benefits– “Consumer surplus”– “Producer surplus” [returns to
owners & fixed inputs]
Competitive Equilibrium Social Optimum
NSF Interdisciplinary Modeling Workshop – July 2005
Welfare Analysis – Economic Surplus
Consumer Surplus
Producer Surplus
WP
W
WS
WD
*W
*WP
NSF Interdisciplinary Modeling Workshop – July 2005
2. Pricing Aquatic Ecosystems
NSF Interdisciplinary Modeling Workshop – July 2005
The Diamond-Water Paradox
Diamond fetch very high prices, although they have limited usefulness. Water is essential to life, but fetches very low prices.
WHY?
NSF Interdisciplinary Modeling Workshop – July 2005
Total vs. Marginal Value -- Water
W
Value
WMV
WTV
WP
AggWS
NSF Interdisciplinary Modeling Workshop – July 2005
Total vs. Marginal Value -- Gems
G
Value
GMV
AggGS
GP
GTV
NSF Interdisciplinary Modeling Workshop – July 2005
Answering the Paradox
Water: Adequate supplies produce low marginal value (even though basic water needs are highly valued).
Diamonds: Limited supplies
produce high marginal value.
NSF Interdisciplinary Modeling Workshop – July 2005
Pricing Aquatic Ecosystems
Whole vs. components
Value vs. supply cost
Use vs. nonuse
NSF Interdisciplinary Modeling Workshop – July 2005
Models for Valuing Ecosystems
Market-based (Revealed Preferences): – Expenditures on services – fish & fishing;
whale watching – Opportunity cost of laws –Lagragian
multipliers on constraint functions – Replacement cost
Experiment-based (Stated Preferences): – Trade-offs between service levels & prices– Willingness to support tax referenda– Expressed willingness to pay
NSF Interdisciplinary Modeling Workshop – July 2005
Example: Value of ∆ Fishery Quality
fP
f
2( , )fD P Q
1( , )fD P Q
*fP
NSF Interdisciplinary Modeling Workshop – July 2005
Example: Value of Wetlands (Earnhart, Land Econ., 2001)
Hedonic housing value – price differentials for homes adjacent to restored wetland vs. not adjacent to any distinct features– Proximity to L.I. Sound, river, stream ~ + 3%– Proximity to restored marsh ~ +16%– Proximity to disturbed marsh ~ -13%
Conjoint choice – selecting between hyp. homes differing in amenities & price – All values ~ 80 – 120%
NSF Interdisciplinary Modeling Workshop – July 2005
Example: “The Value of the World’s Ecosystem Services & Natural Capital” (Costanza et al., Nature, 1997)
Benefits transfer – borrow marginal values from literature and apply them to increments to env. quality or natural resources
Multiply by total quantity of natural resources
Total value ~ $33 trillion
NSF Interdisciplinary Modeling Workshop – July 2005
Example: “The Value …” Critique
“Serious underestimate of infinity.”
Total value vs. marginal value– Tools best applied to small changes from
status quo
Double - counting
NSF Interdisciplinary Modeling Workshop – July 2005
3. Hydro-Economic Models
NSF Interdisciplinary Modeling Workshop – July 2005
Hydro-economic Topics
Dam management balancing hydropower, recreation, ecological benefits
Administered water allocation Policy-simulation, e.g.,
– Auctioned access to locks– Targeted NPS abatement– Instream flow management– Economic forecasting of land
use/hydrologic change
NSF Interdisciplinary Modeling Workshop – July 2005
Example: Downstream Impacts of Development (Johnston et al. JWRPM, 2006)
Determine the downstream economic value of low-impact development:
Identify impact categories (flooding, water quality,…)
Use weather series & HSPF to compute stage, flow, and flood frequencies for different development scenarios
Attach typical “prices” to impacts Calculate economic impact of each scenario Engineering costing of each scenario
NSF Interdisciplinary Modeling Workshop – July 2005
Example: Spatial Management of Ag. Pollution (Braden et al., AJAE, 1989)
Max π = Revenues – Costss.t. Crop production functions
Spatial pollution transport functions < T*Identifies actions (crop, tillage)
by location that minimize economic losses
NSF Interdisciplinary Modeling Workshop – July 2005
Hydro-economic Challenges
Scale: Markets vs watersheds Time: Water cycles vs
Economic cycles
NSF Interdisciplinary Modeling Workshop – July 2005
4. Bioeconomic Models
NSF Interdisciplinary Modeling Workshop – July 2005
Bioeconomic Topics
Fisheries management Floodplain & wetlands
management Forecasting landscape change
and effects on ecosystems
NSF Interdisciplinary Modeling Workshop – July 2005
Example: Efficient Protection of Fish Habitat (Braden et al., WRR, 1989)
Max π (crops, tillage, pesticides)
s.t. Prob {HSI (sed., chem.) > H*} > R
NSF Interdisciplinary Modeling Workshop – July 2005
Example: Economic/Runoff/Fish/Model
[Braden et al., WRR, 1989]
NSF Interdisciplinary Modeling Workshop – July 2005
Example: Cost/Habitat Suitability
[Braden et al., WRR, 1989]
NSF Interdisciplinary Modeling Workshop – July 2005
Fish Habitat: Discharges vs. Impacts (Braden et al, AJAE,
1991)
Impact Targets:Min C(x) s.t. Pr{q(x,h[x],ε)>Q} > A
Q = Habitat Qual., A = reliability
ε = stochastic factorDischarge Standards (Proxy):
Min C(x) s.t. Pr {h(x) > H} > Bh intermed to q; H linked to Q
NSF Interdisciplinary Modeling Workshop – July 2005
Example: Habitat Impacts vs Discharges
[Braden et al., AJAE, 1991].
NSF Interdisciplinary Modeling Workshop – July 2005
Example: Floodplain Management for Crops and Fish in Bangladesh (Islam & Braden, Env. Devel. Econ., 2006)
MaxHi Σc,t φtNRcit*Hcit + Σf,t φtNRfi(qfit)*Hfit
s.t. ΣcHci + Σf Hfi < H all t [area]
qfit = gfit(Hfit) [nonlinear production]
Differentiates production functions by land capability, crop, and species types
NSF Interdisciplinary Modeling Workshop – July 2005
Floodplain Model Implementation
Fourier analysis (econometric) simulation of flood levels
Monthly average water levels -> flood coverages w/ digital elevation model
Land capabilities identified Capabilities changeable with levees Optimize land allocations to
activities by max economic returns
NSF Interdisciplinary Modeling Workshop – July 2005
Bioeconomic Modeling Challenges
Matching spatial and temporal scales
Model complexity Simplifications that lose
information (e.g., averaging)
NSF Interdisciplinary Modeling Workshop – July 2005
5. Benefit-Cost Models
NSF Interdisciplinary Modeling Workshop – July 2005
Policy Analysis
Maximum Net Benefits– Potential Pareto Optimality – costs not
actually compensated– Function of existing distribution
Discounting– Opportunity cost of time
Max NPV =
Σt { (Benefits)t - (Costs)t} (1 + r)t
NSF Interdisciplinary Modeling Workshop – July 2005
6. Risk and Uncertainty
NSF Interdisciplinary Modeling Workshop – July 2005
Sources of Variability
Weather Ecological dynamics Geology/geography/
topography Technology Households Culture Economy
NSF Interdisciplinary Modeling Workshop – July 2005
Modeling Variability
Statistical confidence intervals Monte Carlo simulation
NSF Interdisciplinary Modeling Workshop – July 2005
Challenges
Interactions of systems Differences in scale & detail Structural change Pure uncertainty
– Precautionary principle
NSF Interdisciplinary Modeling Workshop – July 2005
7. Summary Remarks
Economics adds people -- systematically
Total value vs. price & cost Integrating role Different disciplinary scales
and time-frames challenge integration