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Economic Principles

The Value of Water

Basic Economic Principles

There are several economic principles essential to water planning. Failure to incorporate each of them on a consistent basis can lead to improper selection of water projects.

  1. Discounting costs and benefits over the life of the planning horizon to estimate the present value of a project. Discounting is the only way to accurately compare and evaluate projects that incur costs and benefits at different points of time.

  2. Closer examination of the relationship between user demand and price, especially considering the reaction of quantity demand to water prices and the opportunity to transfer water from one use to another. The current planning regime often treats demand as a static concept and does not adjust demand forecasts to account for rising water prices or alternative patterns of water use.

  3. The definition of a drought and the way the probability of drought is distributed over the 50 year planning horizon. The current planning protocol appears to overestimate the expected severity and frequency of drought conditions. This would exaggerate the benefits of water development projects and could result in wasteful investment of limited funds.

  4. Analysis of the cost and benefits of individual projects. Unless cost-benefit analysis is conducted for individual projects, a regional or state plan may actually consist of several good projects that subsidize other projects where the benefits do not outweigh costs. More efficient use of scarce water resources and water development funds requires funding only the specific projects that generate positive benefits.

  5. Costs and benefits should include impacts on environmental values such as instream flows, bays and estuaries, and recreational values. Current plans do not evaluate the impact of water development projects on environmental values. This has the effect of underestimating the cost and/or overestimating the benefits associated with a particular project.