Slide 1

John B. Braden University of Illinois at Urbana-Champaign Economic Modeling for Water Resources NSF Interdisciplinary Modeling Workshop July 2005

Slide 2

Thanks: Laurel Saito Heather Segale Xiaolin Ren

Slide 3

NSF Interdisciplinary Modeling Workshop July 2005 Contributions of Economics Understand Behaviors Responses to institutions & policies Market power (size, information) Positive analysis Design Institutions & Policies Benefit/cost analysis Planning for behaviors Normative analysis

Slide 4

NSF Interdisciplinary Modeling Workshop July 2005 Limitations of Economics Anthropocentric Utilitarian Statistical Allocational (efficiency) Material

Slide 5

NSF Interdisciplinary Modeling Workshop July 2005 Economic Modeling Theory generate hypotheses Econometrics test hypotheses Operations Research simulate outcomes optimize complex systems

Slide 6

NSF Interdisciplinary Modeling Workshop July 2005 Outline of Presentation Basic Economic Models Pricing Aquatic Ecosystems Hydro-Economic Models Bio-Economic Models Benefit-cost Analysis Risk and Uncertainty Summary Remarks

Slide 7

NSF Interdisciplinary Modeling Workshop July 2005 Resources for Lecture Griffin, R.C. Water Resource Economics. MIT Press (forthcoming) Young, R.A. Determining the Economic Value of Water. Resources for the Future (2005) Other books & articles on website

Slide 8

NSF Interdisciplinary Modeling Workshop July 2005 1. Basic Economic Models

Slide 9

NSF Interdisciplinary Modeling Workshop July 2005 Agent Models Consumers Maximize Utility Max u(Y,w), u y, u w > 0 u yy, u ww < 0 s.t. P Y Y + p w w < B Producers Maximize Profit Max = p 1 y 1 i c i x i c w w s.t. y 1 = f(X, w), f x, f w > 0; f xx, f ww < 0

Slide 10

NSF Interdisciplinary Modeling Workshop July 2005 Marginal Analysis Marginal benefits = incremental demand price Marginal costs = incremental supply price Operating returns vs. fixed costs

Slide 11

NSF Interdisciplinary Modeling Workshop July 2005 Supply Model Input Choice

Slide 12

NSF Interdisciplinary Modeling Workshop July 2005 Supply Model Output

Slide 13

NSF Interdisciplinary Modeling Workshop July 2005 Aggregate Supply

Slide 14

NSF Interdisciplinary Modeling Workshop July 2005 Demand Model

Slide 15

NSF Interdisciplinary Modeling Workshop July 2005 Aggregate Demand

Slide 16

NSF Interdisciplinary Modeling Workshop July 2005 Nonrival (Public) Goods Rival Ordinary goods that only one person can consume Nonrival Goods that can be consumed by many simultaneously Excluability allows pricing

Slide 17

NSF Interdisciplinary Modeling Workshop July 2005 Public Goods & Economic Value

Slide 18

NSF Interdisciplinary Modeling Workshop July 2005 Markets Producers offer good & buy inputs Consumers bid for goods & supply labor Prices coordinate producers & consumers Output markets (p y, p w ) Input markets (c i, c w ) Parametric to individuals

Slide 19

NSF Interdisciplinary Modeling Workshop July 2005 Market Model

Slide 20

NSF Interdisciplinary Modeling Workshop July 2005 Welfare Analysis (normative) Maximize Net Benefits Consumer surplus Producer surplus [returns to owners & fixed inputs] Competitive Equilibrium Social Optimum

Slide 21

NSF Interdisciplinary Modeling Workshop July 2005 Welfare Analysis Economic Surplus Consumer Surplus Producer Surplus

Slide 22

NSF Interdisciplinary Modeling Workshop July 2005 2. Pricing Aquatic Ecosystems

Slide 23

NSF Interdisciplinary Modeling Workshop July 2005 The Diamond-Water Paradox Diamond fetch very high prices, although they have limited usefulness. Water is essential to life, but fetches very low prices. WHY?

Slide 24

NSF Interdisciplinary Modeling Workshop July 2005 Total vs. Marginal Value -- Water

Slide 25

NSF Interdisciplinary Modeling Workshop July 2005 Total vs. Marginal Value -- Gems

Slide 26

NSF Interdisciplinary Modeling Workshop July 2005 Answering the Paradox Water: Adequate supplies produce low marginal value (even though basic water needs are highly valued). Diamonds: Limited supplies produce high marginal value.

Slide 27

NSF Interdisciplinary Modeling Workshop July 2005 Pricing Aquatic Ecosystems Whole vs. components Value vs. supply cost Use vs. nonuse

Slide 28

NSF Interdisciplinary Modeling Workshop July 2005 Models for Valuing Ecosystems Market-based (Revealed Preferences): Expenditures on services fish & fishing; whale watching Opportunity cost of laws Lagragian multipliers on constraint functions Replacement cost Experiment-based (Stated Preferences): Trade-offs between service levels & prices Willingness to support tax referenda Expressed willingness to pay

Slide 29

NSF Interdisciplinary Modeling Workshop July 2005 Example: Value of Fishery Quality

Slide 30

NSF Interdisciplinary Modeling Workshop July 2005 Example: Value of Wetlands (Earnhart, Land Econ., 2001) Hedonic housing value price differentials for homes adjacent to restored wetland vs. not adjacent to any distinct features Proximity to L.I. Sound, river, stream ~ + 3% Proximity to restored marsh ~ +16% Proximity to disturbed marsh ~ -13% Conjoint choice selecting between hyp. homes differing in amenities & price All values ~ 80 120%

Slide 31

NSF Interdisciplinary Modeling Workshop July 2005 Example: The Value of the Worlds Ecosystem Services & Natural Capital (Costanza et al., Nature, 1997) Benefits transfer borrow marginal values from literature and apply them to increments to env. quality or natural resources Multiply by total quantity of natural resources Total value ~ $33 trillion

Slide 32

NSF Interdisciplinary Modeling Workshop July 2005 Example: The Value Critique Serious underestimate of infinity. Total value vs. marginal value Tools best applied to small changes from status quo Double - counting

Slide 33

NSF Interdisciplinary Modeling Workshop July 2005 3. Hydro-Economic Models

Slide 34

NSF Interdisciplinary Modeling Workshop July 2005 Hydro-economic Topics Dam management balancing hydropower, recreation, ecological benefits Administered water allocation Policy-simulation, e.g., Auctioned access to locks Targeted NPS abatement Instream flow management Economic forecasting of land use/hydrologic change

Slide 35

NSF Interdisciplinary Modeling Workshop July 2005 Example: Downstream Impacts of Development (Johnston et al. JWRPM, 2006) Determine the downstream economic value of low-impact development: Identify impact categories (flooding, water quality,) Use weather series & HSPF to compute stage, flow, and flood frequencies for different development scenarios Attach typical prices to impacts Calculate economic impact of each scenario Engineering costing of each scenario

Slide 36

NSF Interdisciplinary Modeling Workshop July 2005 Example: Spatial Management of Ag. Pollution (Braden et al., AJAE, 1989) Max = Revenues Costs s.t. Crop production functions Spatial pollution transport functions < T* Identifies actions (crop, tillage) by location that minimize economic losses

Slide 37

NSF Interdisciplinary Modeling Workshop July 2005 Hydro-economic Challenges Scale: Markets vs watersheds Time: Water cycles vs Economic cycles

Slide 38

NSF Interdisciplinary Modeling Workshop July 2005 4. Bioeconomic Models

Slide 39

NSF Interdisciplinary Modeling Workshop July 2005 Bioeconomic Topics Fisheries management Floodplain & wetlands management Forecasting landscape change and effects on ecosystems

Slide 40

NSF Interdisciplinary Modeling Workshop July 2005 Example: Efficient Protection of Fish Habitat (Braden et al., WRR, 1989) Max (crops, tillage, pesticides) s.t. Prob {HSI (sed., chem.) > H*} > R

Slide 41

NSF Interdisciplinary Modeling Workshop July 2005 Example: Economic/Runoff/Fish/Model [Braden et al., WRR, 1989]

Slide 42

NSF Interdisciplinary Modeling Workshop July 2005 Example: Cost/Habitat Suitability [Braden et al., WRR, 1989]

Slide 43

NSF Interdisciplinary Modeling Workshop July 2005 Fish Habitat: Discharges vs. Impacts (Braden et al, AJAE, 1991) Impact Targets: Min C(x) s.t. Pr{q(x,h[x],)>Q} > A Q = Habitat Qual., A = reliability = stochastic factor Discharge Standards (Proxy): Min C(x) s.t. Pr {h(x) > H} > B h intermed to q; H linked to Q flood coverages w/ digital elevation model Land capabilities identified Capabilities changeable with levees Optimize land allocations to activities by max economic returns">

NSF Interdisciplinary Modeling Workshop July 2005 Floodplain Model Implementation Fourier analysis (econometric) simulation of flood levels Monthly average water levels -> flood coverages w/ digital elevation model Land capabilities identified Capabilities changeable with levees Optimize land allocations to activities by max economic returns

Slide 47

NSF Interdisciplinary Modeling Workshop July 2005 Bioeconomic Modeling Challenges Matching spatial and temporal scales Model complexity Simplifications that lose information (e.g., averaging)

Slide 48

NSF Interdisciplinary Modeling Workshop July 2005 5. Benefit-Cost Models

Slide 49

NSF Interdisciplinary Modeling Workshop July 2005 Policy Analysis Maximum Net Benefits Potential Pareto Optimality costs not actually compensated Function of existing distribution Discounting Opportunity cost of time Max NPV = t { (Benefits) t - (Costs) t } (1 + r)t

Slide 50

NSF Interdisciplinary Modeling Workshop July 2005 6. Risk and Uncertainty

Slide 51

NSF Interdisciplinary Modeling Workshop July 2005 Sources of Variability Weather Ecological dynamics Geology/geography/topography Technology Households Culture Economy

Slide 52

NSF Interdisciplinary Modeling Workshop July 2005 Modeling Variability Statistical confidence intervals Monte Carlo simulation

Slide 53

NSF Interdisciplinary Modeling Workshop July 2005 Challenges Interactions of systems Differences in scale & detail Structural change Pure uncertainty Precautionary principle

Slide 54

NSF Interdisciplinary Modeling Workshop July 2005 7. Summary Remarks Economics adds people -- systematically Total value vs. price & cost Integrating role Different disciplinary scales and time-frames challenge integration