The Economics of Water Resource Allocation: Valuation Methods and Policy Implications

Abstract

In this chapter a ‘watershed economics approach’ that could be applied in Cyprus is proposed which is composed of two important stages. In Stage I economic valuation techniques are used to establish the economic value of the competing demands for surface and groundwater, incorporating where necessary an analysis of water quality. The valuation exercise allows the objective balancing of demands based upon the equi-marginal principle to achieve economic efficiency. In Stage II a policy impact analysis is proposed which addresses issues of social equity and the value of water for environmental/ecological purposes. The analysis is undertaken within the confines of the watershed; the most natural unit for the analysis of water allocation and scarcity since it determines the hydrological links between competing users and thus the impacts of one user upon another. The methodology is encapsulated by a case study of the Kouris watershed in Cyprus.

Appendices

Appendix

Terminology

• Marginal Value : is a term used in economics to refer to the change in economic value associated with a unit change in an economic choice variable. The efficient balance of demands from a given source is found where the marginal value (benefit) of water is equated across users. In any given context efficiency is achieved where the marginal value of water is equated to marginal social cost.

• Price Elasticity : Measures the responsiveness of demand to price changes. Characterizes the demand function and tells the policy maker the extent to which prices must change to cause demand to fall to a particular, e.g. efficient, sustainable, level.

• Income Elasticity : Measures the extent to which the demand for water varies with income. Tells the policy maker whether water is a necessity or a luxury good and provides one way in which to assess the fairness of pricing policies. In combination with PED can be used to estimate welfare changes resulting from policies.

• Willingness to Pay : Estimates the strength of demand for water as an environmental good. This determines in part the efficient environmental allocation of water.

Valuation Methods

Hedonic analysis: is most commonly applied to variations in housing prices that reflect the value of local environmental attributes. Thus, property prices will reflect the value of a set of characteristics, including environmental characteristics that people consider important when purchasing a property.

Contingent Valuation: is a non-market-based technique that elicits information concerning environmental preferences from individuals through the use of surveys, questionnaires, and interviews. This method enables the market for a public good to be simulated and described and then asks individuals what they would be willing to pay for that good or what they would be willing to accept as compensation if this good were lost or unavailable.

Travel Cost Approach: the basic premise of this method is that the time and the cost expenses that people incur to visit a site represent the price travelers assign to the site and its attributes. Thus, the number of trips realized at different travel cost can provide a robust index of individual’s Willingness to Pay for access to the site.

Distance Function: is used to estimate the economic value of ecosystem products or services that contribute to the production of commercially marketed goods. It is applied in cases where the products or services of an ecosystem are used, along with other inputs, to produce a marketed good.