John B. Braden University of Illinois at Urbana-Champaign
Economic Modeling for Water Resources NSF Interdisciplinary
Modeling Workshop July 2005
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Thanks: Laurel Saito Heather Segale Xiaolin Ren
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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
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NSF Interdisciplinary Modeling Workshop July 2005 Limitations
of Economics Anthropocentric Utilitarian Statistical Allocational
(efficiency) Material
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NSF Interdisciplinary Modeling Workshop July 2005 Economic
Modeling Theory generate hypotheses Econometrics test hypotheses
Operations Research simulate outcomes optimize complex systems
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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
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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
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NSF Interdisciplinary Modeling Workshop July 2005 1. Basic
Economic Models
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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
NSF Interdisciplinary Modeling Workshop July 2005 Supply Model
Input Choice
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NSF Interdisciplinary Modeling Workshop July 2005 Supply Model
Output
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NSF Interdisciplinary Modeling Workshop July 2005 Aggregate
Supply
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NSF Interdisciplinary Modeling Workshop July 2005 Demand
Model
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NSF Interdisciplinary Modeling Workshop July 2005 Aggregate
Demand
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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
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NSF Interdisciplinary Modeling Workshop July 2005 Public Goods
& Economic Value
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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
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NSF Interdisciplinary Modeling Workshop July 2005 Market
Model
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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
NSF Interdisciplinary Modeling Workshop July 2005 2. Pricing
Aquatic Ecosystems
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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?
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NSF Interdisciplinary Modeling Workshop July 2005 Total vs.
Marginal Value -- Water
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NSF Interdisciplinary Modeling Workshop July 2005 Total vs.
Marginal Value -- Gems
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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.
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NSF Interdisciplinary Modeling Workshop July 2005 Pricing
Aquatic Ecosystems Whole vs. components Value vs. supply cost Use
vs. nonuse
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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
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NSF Interdisciplinary Modeling Workshop July 2005 Example:
Value of Fishery Quality
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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%
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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
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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
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NSF Interdisciplinary Modeling Workshop July 2005 3.
Hydro-Economic Models
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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
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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
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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
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NSF Interdisciplinary Modeling Workshop July 2005
Hydro-economic Challenges Scale: Markets vs watersheds Time: Water
cycles vs Economic cycles
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NSF Interdisciplinary Modeling Workshop July 2005 4.
Bioeconomic Models
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NSF Interdisciplinary Modeling Workshop July 2005 Bioeconomic
Topics Fisheries management Floodplain & wetlands management
Forecasting landscape change and effects on ecosystems
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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
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NSF Interdisciplinary Modeling Workshop July 2005 Example:
Economic/Runoff/Fish/Model [Braden et al., WRR, 1989]
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NSF Interdisciplinary Modeling Workshop July 2005 Example:
Cost/Habitat Suitability [Braden et al., WRR, 1989]
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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
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NSF Interdisciplinary Modeling Workshop July 2005 Bioeconomic
Modeling Challenges Matching spatial and temporal scales Model
complexity Simplifications that lose information (e.g.,
averaging)
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NSF Interdisciplinary Modeling Workshop July 2005 5.
Benefit-Cost Models
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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
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NSF Interdisciplinary Modeling Workshop July 2005 6. Risk and
Uncertainty
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NSF Interdisciplinary Modeling Workshop July 2005 Sources of
Variability Weather Ecological dynamics
Geology/geography/topography Technology Households Culture
Economy
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NSF Interdisciplinary Modeling Workshop July 2005 Modeling
Variability Statistical confidence intervals Monte Carlo
simulation
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NSF Interdisciplinary Modeling Workshop July 2005 Challenges
Interactions of systems Differences in scale & detail
Structural change Pure uncertainty Precautionary principle
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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