Friday, April 15, 2011

Scarcity and the Proper Pricing of Water

Recall the famous diamond-water paradox.  While water is absolutely essential to human life, no one really needs a diamond to survive.  Yet, diamonds are many times more highly valued than water.  Of course, this seeming paradox is explained by the supply side.  Water is plentiful and diamonds are scarce.

This article appeared in the April 12th, 2011 issue of New York Times.  The article discusses the growing demands for water, especially in the southwest.

As we know, you cannot just wish away scarcity.  The existence of scarcity means that some system must be used for deciding allocation.  Normally, we rely on markets and prices to handle that.  But, there really are very few markets for water in the U.S.  The single biggest use of freshwater in the U.S. is irrigation and mostly in arid western states.  But the water for such uses is provided at no charge.  (Careful here:  people using irrigation do pay a price, but that is for access and delivery cost recovery.  The original grant of water into the irrigation system is generally not priced.)

The story indicates that water (more accurately, the scarcity of water) will become an increasingly important issue.  Of course, scarcity (and the handling of the resulting allocation problem) is not something new.  But, the combination of a very important item (water) facing an era where pricing will begin to reflect opportunity costs brings the potential for great disruptions in how we produce food as well as locate our communities.

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