Q - water 3. Q - water. Q - water. Q - water. A new equimarginal condition. Lecture 21 & 22. A single farmer. A single farmer.

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1 Lecture 21 & 22 A new equimarginal condition First Second The efficient allocation of a resource at one point in time, the case of surface water. Third - The MNB to every user should be equal at the efficient allocation. Tons Yield

2 Marginal M. 7 8 MR MC If Marginal Net Rev. >0 then s can be increased by using more water MR MC 9 10 Marginal s are maximized when =0 MR M. M

3 As long as there is at least gallons of water, profits can be maximized Suppose there isn t enough water. s cannot be maximized. The marginal value of water will not be driven to zero. 13 Q 14 Suppose there isn t enough water. The positive marginal value of water is called marginal scarcity rent Q 15 Suppose there are 2 identical s, both who would like to use gallons of water 16 If there is less than 2x, then there won t be enough water for both s to maximize their profits. We have an allocation problem. If there is exactly gallons and Farmer 1, uses it all, then the profits will be as shown

4 If Farmer 1 gives a little bit of his water to Farmer 2, then profits change as shown and total profits goes up. As long as the marginal net revenue to Farmer #2 is greater than that to Farmer #1, then total profits will be increased by moving water from 1 to 2. decrease increase 19 decrease increase 20 The efficient allocation is achieved when the to Farmer #1 is equal to the of water to Farmer #2. In this case, because the s are identical this occurs where there water use is equal, but in general that will not hold. Marginal Scarcity Rent As in the single-user case, because of the limited nature of the resource, at the optimum the marginal scarcity rent will not be zero. This tells us how much society would benefit if we could obtain a little more of the resource. /2 /2 /2 / Team Exercise: Answer Al and Betty both share a water supply. For Al the cost to use water is essentially free because he lives downstream of the supply. Betty, has to pump water, meaning every unit she uses costs her 1 /unit MB A MB B 1) What is the marginal net benefit to Al of the 20th unit that he uses? (pick the nearest answer) A. =0 B. =1 C. =2 D. =3 E. = units of water used 4

5 2) What is the marginal net benefit to Betty of the 20th unit that she uses? A. =0 B. =1 C. =2 D. =3 E. =4 3) Suppose Betty already has a right to 20 units of water. How much would she be willing to pay per unit for a marginal increase in her water rights? A. =0 B. =1 C. =2 D. =3 E. =4 4) Suppose there is 100 units of water available. What would be the efficient allocation of water between Al and Betty? A. A=30, B=70 B. A=40, B=60 C. A=50, B=50 D. A=60, B=40 E. None of the above 5) Suppose there are only 15 units of water available in the reservoir. How much would Al use and how much would Betty use in the efficient allocation? A. A=0, B=15 B. A=5, B=10 C. A=10, B=5 D. A=15, B=0 E. None of the above 6) Suppose there are 30 units of water available. How much would Al use and how much would Betty use in the efficient allocation? A. A=0, B=30 B. A=10, B=20 C. A=20, B=10 D. A=30, B=0 E. None of the above 7) Suppose there are 30 water rights and Al owns all 30. What would be the increase in net benefits that could be achieved if Al decides to sell a portion of his rights to Betty instead of keeping all of the rights to himself? Shade in the appropriate area on your graph 5

6 Riparian vs. Prior Appropriation Riparian rights: If you have access to a waterway, you can extract what you need. You are not allowed to sell water to others Prior appropriation: Rights are specified to individuals in terms of the quantity of water they can extract. These rights can be sold. Those with the oldest rights, more seniority, have more certainty that they will get their water in the event of a drought. Team Answer Which system of water rights allocation is more likely to lead to an efficient allocation and why? When do riparian rights tend to be more efficient (i.e. maximizing net benefits at minimal cost). Don t forget about transaction costs. Where is the failure of exclusivity under Riparian Rights going to be a problem? 6

7 Municipal Water Pricing Where is transferability under Prior Appropriation going to have the greatest value? Which system(s) will satisfy the 3 rd equimarginal condition, the MNB to every user should be equal at the efficient allocation? A. Uniform rate structure B. Declining block rate structure C. Inverted block rate structure D. Seasonal rate structure Municipal Water Pricing Which system(s) will satisfy the 1 st equimarginal condition, MB = MC? A. Uniform rate structure B. Declining block rate structure C. Inverted block rate structure D. Seasonal rate structure 7

8 8) Suppose that the river has 30 units of water in it, and Al and Betty use all of it, efficiently allocating the water between the two of them. However, this leaves no water for fish in the river. Would this be socially efficient? 8) Suppose that the river has 30 units of water in it, and Al and Betty efficiently use all of it. However, this leaves no water for fish in the river. Would this be socially efficient? How would you adjust the water policy to achieve an efficient allocation? Review Public Goods A public good is non-rival and non-exclusive. Externalities An externality occurs when the benefits or costs associated with use or ownership accrue to someone other than the owner. 8

9 The nature of water Is water a private good or a public good? Are there externalities associated with the use of water quantity (not quality)? When, if ever, are these true for water? When, if ever, is there a justification for public intervention in the supply of water? Brazos River & Senior Rights Prepare to debate either side Pro: By taking away water rights from the senior rights holders, net benefits to society increased. Con: By taking away water rights from the senior rights holders, social efficiency was diminished. Scope of work Gm8 Suppose we want to know if it would be economically efficient to build the pipeline. What would we need to know? Carry out a study to assess whether it would be economically efficient to build the pipeline from the Missouri River to the Colorado River. Step 1: Identify benefits of the project. Identify costs of the project. Step 2: Estimate the dollar value of the benefits Step 3: Estimate the dollar value of the costs 9