Transcript Basic Need, Merit, or Economic Good

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 Efficiency
Marginal Cost = Marginal Benefits
Some Economic Indicators
• NPV
Strong:
– Choosing among mutually exclusive
projects
– Decide if the project can be funded
Weak:
– Sensitive to interest rate
– No information about degree of
acceptability
( B  C )t
NPV  
(1  r )t
• Internal Rate of Return (IRR)
Strong:
– Maximize the return when we have Limited
fund
– Used to rank projects
– Decide if the project can be funded
Weak:
– No information on the size of the project
( B  C )t
(r @ 
 0)
t
(1  r )
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
BC ratio
Bt
 (1  r )t

Ct
 (1  r )t
Strong:
– Rank projects according to degree of
acceptability
– Decide if the project can be funded
Weak:
– Sensitive to interest rate
Economic Efficiency
TC
P
TB
MC
max
AC
MB
Q*
Quantity
TC: Total Cost
TB: Total Benefit
MC: Marginal Cost
AC: Average Cost
MB: Marginal Benefit
ITB connection
Economic Efficiency
TC
P
TB
Optimality Condition
MC
max
Rising limb = supply curve
Below the falling part of AC
Higher the rising part of AC
Affected by variable costs
AC
MB
Q*
Quantity
= Demand Curve
= Benefits associated with
One Unit increase in output
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
1.4
1.3
3
Unit Price ($/m )
1.2
1.1
1
0.9
0.8
0.7
0.6
0.5
7
7.5
8
Monthly Demand (Mm3)
8.5
9
RESULTS: M&I Supply Curve
1.6
1.4
import 1
3
marginal cost ($/m )
1.2
1
seawater
desalination 2
0.8
0.6
seawater
desalination 1
brackish water
treatment 2
0.4
brackish water
treatment 1
0.2
import 2
0
2
3
4
5
6
7
8
monthly supply (Mm3)
9
10
11
12
RESULTS: 2010 Equilibrium Point
1.4
3
marginal cost / price ($/m )
1.3
supply
1.2
1.1
1
0.9
0.8
0.7
2010 demand
0.6
0.5
2
3
4
5
6
7
8
9
monthly supply / demand (Mm3)
Figure 1: 2010 supply-demand equilibrium point
10
11
Cash Flow Example
Year
Investment
Cost
1
2
3
100000
50000
50000
O&M Cost
4
5
6
7
8
9
10
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
50000
50000
50000
50000
50000
50000
50000
Revenues
NPVr
0
0
0
37566
34151
31046
28224
25658
23325
21205
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
Interest
rate
227012
201174
IRR
350000
325000
300000
IRR=0.068
NPVc
250000
NPVr
225000
200000
175000
Interest Rate
0.11
0.1
0.09
0.08
0.07
0.06
0.05
0.04
0.03
0.02
0.01
150000
0
NPV
275000
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:
P
• Shifts in Demand:
–
–
–
–
–
Customer preferences
Number of customers
Customer income
Price of related goods
Availability of alternatives
Q
Market Demand
• Price elasticity of the
demand:
P
– More elastic at high prices
5
– Rigid at low prices
– Perfectly elastic when
E=infinity, means no one will
3
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.
E=-5
E=-1
E=-0.2
1
1
3
5
Q
Market Supply
• Market supply: the amount
that producers are willing
to sell/produce at different
prices
P
• Shifts in supply curve:
– Technological advances
– Favorable production
conditions
– Lower input cost
Q
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
P
Demand
supply
surplus
shortage
Q
Irrigation Water Prices in
Israel