Notes on Economics – McKinney i 1/10/2003 Economics Analysis of Water Resources Lecture Notes CE 385D: Water Resources Planning and Management Daene C. McKinney Department of Civil Engineering The University of Texas at Austin Contents Section Page 1. Engineering Economics ........................................................................................................... 1 1.1 Choosing Among Feasible Alternatives .............................................................................. 1 1.2 Cost-effectiveness analysis .................................................................................................. 2 1.3 Benefit-cost analysis ............................................................................................................ 2 1.3.1 Interest Rate Calculations ............................................................................................. 3 1.4 Financial Analysis................................................................................................................ 4 1.5 Discount Rate....................................................................................................................... 5 2. Demand ................................................................................................................................... 11 2.1 Introduction........................................................................................................................ 11 2.2 Consumer’s Problem.......................................................................................................... 12 2.3 Demand.............................................................................................................................. 15 2.4 Willingness-to-pay............................................................................................................. 15 2.5 Elasticity (of demand)........................................................................................................ 18 2.6 Water Values in the US...................................................................................................... 20 3. Supply...................................................................................................................................... 21 3.1 Introduction........................................................................................................................ 21 3.2 The Firm’s Problem ........................................................................................................... 24 3.3 Crop Production Functions with Water ............................................................................. 29 3.3.1 Introduction................................................................................................................. 29 3.3.2 Types of Production Function Models........................................................................ 30 3.3.3 Example: Production of wheat in the Maipo basin, Chile ......................................... 32 3.4 Opportunity Cost................................................................................................................ 40 3.5 Average Cost Pricing ......................................................................................................... 40 3.6 Criteria for Decision Making............................................................................................. 41 3.7 Externalities ....................................................................................................................... 45 3.8 Production of Multiple Outputs ......................................................................................... 46 4. Water Rights and Markets....................................................................................................51 4.1 Introduction........................................................................................................................ 51 4.2 Water Rights ...................................................................................................................... 52 4.2.1 Riparian water rights systems ..................................................................................... 54 4.2.2 Appropriative water rights systems ............................................................................ 54 4.3. Water Markets.................................................................................................................... 56 4.3.1 Right to divert or consume.......................................................................................... 56Notes on Economics – McKinney ii 1/10/2003 4.3.2 Tradable water rights markets..................................................................................... 58 4.3.3 Modeling tradable water rights markets ..................................................................... 61 Exercises ...................................................................................................................................... 63 References.................................................................................................................................... 73Notes on Economics – McKinney 1 1/10/2003 1. Engineering Economics 1.1 Choosing Among Feasible Alternatives Economic analysis, or the understanding and prediction of decision making under conditions of resource scarcity, plays a major role in the planning, design and management of sustainable water resource systems. Allocation of water among competing uses to obtain an optimum value in terms of market or welfare measures is one of the main problems of water resources planners. Price theory is very relevant where markets are operating efficiently, whereas welfare economics seeks to maximize human welfare in situations where desirable social gains and undesirable social costs are not fully accounted for in a profit maximizing, market economy (North, 1985). Price theory and welfare economics tend to focus on static analyses of projects, whereas, financial analysis considers the time value of investments and decisions. In this section, we will consider some aspects of financial analysis. Choice is governed by economic and financial feasibility and acceptability with respect to social and environmental impacts. Here we want to consider investment analysis which serves as a guide for allocating resources between present