Water Resource Economics Spring 202

Water Resource Economics Water Resource Economics Spring 2024 Points (2-3 pages including tables/figures)

Water resource economics involves analyzing different urban water supply programs to determine which is the most economically efficient and beneficial from the perspective of the water buyers and suppliers within a large, poor city. Two distinct programs are proposed, each with different mechanisms of supply, pricing, and coverage, and an evaluation involves calculating the total annual economic benefits (TAEB) for each.

The first program supplies a minority of the population with cheap piped water, delivering 10,000 acre-feet (ac-ft) per year at a price equal to the average cost of supply, which is $300 per ac-ft. The remaining water must be purchased from street vendors at a higher price of $900 per ac-ft. The second program aims to supply the entire population through a centralized system that provides 70,000 ac-ft of water at a constant price of $600 per ac-ft, which equals the average cost of supply for the entire system. The maximum willingness to pay for water among residents reaches up to $1,650 per ac-ft, indicating substantial consumer surplus potential.

In this analysis, the focus is on computing the total annual economic benefits (TAEB), which include consumer surplus (CS), total revenue (TR), and total costs (TC) for each program, to evaluate which alternative offers better economic outcomes for the city's stakeholders. The calculations utilize essential concepts such as the demand curve, supply costs, and price settings, grounding the comparison in economic theory and demand-supply analysis.

Calculate the Total Annual Economic Benefits (TAEB) for Each Program

Assumptions and Data Summary:

• Maximum willingness to pay (demand intercept): $1,650 per ac-ft
• Demand function: downward sloping, with maximum price $1,650 at zero quantity
• Program 1:
• Supply from utility: 10,000 ac-ft at $300 per ac-ft
• Remaining demand met from street vendors at $900 per ac-ft
• Demand for water (Qd): depends on price; for simplicity, assume linear demand
• Program 2:
• Supply: 70,000 ac-ft at $600 per ac-ft (constant price)

Calculations will be based on the following demand function assumption:

Qd = 1650 - P, where P is the price per ac-ft.

At maximum willingness to pay ($1,650), demand is zero; at price $300, demand is 1350 ac-ft.

For simplicity, the demand at each program can be approximated using the demand curve, and consumer surplus is computed accordingly.

Program 1: Partial Supply

Supply from utility: 10,000 ac-ft at $300. The remaining demand is unmet by utility and purchased from street vendors at $900.

Total demand at $900: Qd = 1650 - 900 = 750 ac-ft.

But since total utility supply is only 10,000 ac-ft, and demand at $300 is 1350 ac-ft, total demand is assumed to be 1350 ac-ft.

Consumer surplus (CS):

• Maximum willingness to pay: $1,650
• Price paid by utility users: $300
• Quantity supplied by utility: 10,000 ac-ft

Average consumer surplus per unit for utility users: (1650 - 300) / 2 = $675 (assuming linearity), and similarly for the rest.

However, a more precise calculation involves integrating the demand curve over the quantities bought at the different prices. Given the linear demand:

Consumer surplus from utility:

CS_utility = 0.5 (1650 - 300) 10,000 = 0.5 1350 10,000 = $6,750,000.

Remaining demand (from street vendors):

Demand at $900: Qd = 1650 - 900 = 750 ac-ft

Total demand: 1350 ac-ft; utility supplies 10,000 ac-ft, which exceeds demand, so correction needed: in reality, demand is at most Qd=1350, and utility supplies 10,000 ac-ft, but supply is limited to 10,000 ac-ft. Given the total demand is 1350, utility supplies 1350 at $300, and the rest (if any) is supplied at the street vendor price.

Since total demand is less than supply, the calculations focus on the total demand of approximately 1350 ac-ft; thus consumer surplus is approximately:

CS ≈ (1/2) (1650 - 300) 1350 = (1/2) 1350 1350 ≈ $911,250.

Total revenue:

TR = Price Quantity = $300 1350 = $405,000.

Total cost:

TC = 300 * 1350 = $405,000.

Therefore, Total Annual Economic Benefits (TAEB):

TAEB = CS + TR - TC = 911,250 + 405,000 - 405,000 = $911,250.

Program 2: Complete System at Uniform Price

Supply: 70,000 ac-ft at $600 per ac-ft.

Demand at $600: Qd = 1650 - 600 = 1050 ac-ft, but total supply is 70,000 ac-ft. Since demand exceeds supply, the supply is the limiting factor.

Consumers buy 70,000 ac-ft at $600.

Consumer surplus:

• Maximum willingness to pay: $1,650
• Price paid: $600

Consumer surplus per unit: (1650 - 600) / 2 = $525 (assuming linear demand).

Total consumer surplus:

CS = 0.5 (1650 - 600) 70,000 = 0.5 1050 70,000 = $36,750,000.

Total revenue: TR = Price Quantity = $600 70,000 = $42,000,000.

Total cost: TC = 600 * 70,000 = $42,000,000.

Total economic benefits:

TAEB = CS + TR - TC = 36,750,000 + 42,000,000 - 42,000,000 = $36,750,000.

Comparison and Recommendation

The calculations demonstrate a significant difference in the total economic benefits between the two programs. Program 1 yields approximately $911,250 in benefits, whereas Program 2 yields around $36,750,000. Based purely on economic efficiency and total benefits, Program 2 provides a substantially higher overall benefit to the city's water stakeholders, primarily due to the larger volume of water supplied at a uniform price closer to the maximum willingness to pay.

However, it's important to consider equity and affordability, especially given the city's poor status. Program 1 offers cheap water to a minority, potentially aiding those with limited means, but at the cost of higher prices and limited coverage. Program 2, while economically superior, might pose affordability challenges for the poorest residents if prices are high relative to their income, despite higher total benefits.

After analyzing the economic benefits, I recommend adopting Program 2 due to its significantly higher total economic benefits. It efficiently allocates water supply across the entire population, maximizes consumer surplus, and leverages economies of scale in infrastructure and supply. Policymakers should incorporate targeted subsidies or tiered pricing strategies to address affordability concerns for the poorest residents, ensuring equitable access without compromising overall economic efficiency.

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