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Chapter+3 +introduction+to+economic+instruments

  1. 1. Economic and Financial Instruments for IWRM Introduction to economic instruments for water management
  2. 2. Goals and objectives of the session <ul><li>To know what are the public good aspects of water benefits </li></ul><ul><li>To manage basic economic concepts of supply and demand, and full cost recovery </li></ul><ul><li>To have clear definitions of economic instrument for water management </li></ul>
  3. 3. Outline <ul><li>Public-good nature of water resources </li></ul><ul><li>Supply and demand </li></ul><ul><li>Main approach: full cost recovery </li></ul><ul><li>Definition of economic instruments </li></ul>
  4. 4. Introduction <ul><li>Economic instruments are increasingly important for IWRM </li></ul><ul><li>Traditional supply-oriented approaches fail to use economic instruments, especially for demand management </li></ul><ul><li>Economic instruments are valuable to implement a more balanced supply-demand management approach to IWRM </li></ul>
  5. 5. Benefits from water <ul><li>Use for drinking, cooking, sanitation </li></ul><ul><li>Industrial use </li></ul><ul><li>Hydroelectric use </li></ul><ul><li>Transportation </li></ul><ul><li>Fishing </li></ul><ul><li>Agricultural use </li></ul><ul><li>Waste assimilation benefits Aesthetic and recreational values </li></ul><ul><li>Non-use values (ecological services, preservation) </li></ul>
  6. 6. Multi-sector use
  7. 7. Public-good nature of water resources
  8. 8. Supply: producers behaviour <ul><li>Try to seek to maximize benefits from the production of a good or service </li></ul><ul><li>Use some technology to transform inputs into some output (or multiple outputs) </li></ul><ul><li>Demand inputs </li></ul><ul><li>Will react to changes in input and output prices </li></ul>
  9. 9. The supply function Quantity supplied Price
  10. 10. The role of variable and fixed costs
  11. 11. Demand: consumers behaviour <ul><li>Have defined preferences for goods and services; </li></ul><ul><li>Seek to maximize the benefits (utility) they get from consumption; </li></ul><ul><li>Consider the costs (price) they have to pay for consuming a good or service; </li></ul><ul><li>Be restricted by their budgets when taking consumption decisions. </li></ul><ul><li>Importance of willingness to pay (WTP) </li></ul>
  12. 12. The demand side and net benefits Price Quantity demanded Net benefits for consumers when a price p* is charged p*
  13. 13. Competitive market
  14. 14. Reasons why markets are not active in the water sector <ul><li>In competitive markets, supply and demand will interact to form an equilibrium price with optimal allocation of resources. </li></ul><ul><li>Competitive firms will recover automatically their production costs (otherwise these are out of the market). </li></ul><ul><li>Competitive markets, however, are seldom feasible for water services given its many public-good features and high transaction costs. </li></ul><ul><li>Monopoly tends to appear in the provision of large infrastructure water services (domestic use, hydropower and irrigation). </li></ul><ul><li>However, costs are still generated and somebody has to pay for them. </li></ul>
  15. 15. Full cost recovery approach: the situation Plus: V: Environmental costs VI: Opportunity costs Supply Costs: I: Operations and maintenance costs only II: Average financial (capital + O&M) cost, with capital valued in terms of historical costs III: Average financial (capital + O&M) cost, with capital costs computed in replacement terms IV: Long run marginal cost of additional supplies
  16. 16. Defining economic instruments <ul><li>Imbalances in supply-demand of water services </li></ul><ul><li>Economic instruments can be used: </li></ul><ul><ul><li>Water tariffs, taxes and subsidies </li></ul></ul><ul><ul><li>Fees, connection charges, abstraction charges and bulk water pricing </li></ul></ul><ul><ul><li>Discharge charges and pollution taxes </li></ul></ul><ul><ul><li>Tradable water permits, pollution permits </li></ul></ul>
  17. 17. Think about it <ul><li>Could you give examples from your own experience regarding the public good nature of water in different circumstances? </li></ul><ul><li>Do you think the full cost recovery policy is currently applied in your country to the water sector? How? Why? </li></ul>
  18. 18. End <ul><li>The next presentation, still related to chapter 3, deals with water valuation methods. </li></ul>