This document discusses various methods for valuing water to support the use of economic instruments for integrated water resource management. It outlines cost-benefit analysis and different approaches for estimating demand and willingness to pay for water. These include demand curves, hedonic pricing, travel cost methods, and contingent valuation. Methods for valuing water as an intermediate good, like agriculture and power generation, are also presented, including residual and alternative cost approaches. The document encourages considering which valuation methods are most useful and feasible given available resources.

1. Economic and Financial
Instruments for IWRM
Water valuation
methods and economic
instruments

2. Goal and objective of the session
 To know about main water valuation
methods for supporting the use of
economic instruments.
 To be able to evaluate the pros and
cons of using specific water valuation
methods in different water situations.

3. Outline
 A cost benefit-analysis framework
 Supply and demand
 Main approach: full cost recovery
 Description of main water valuation methods

4. Introduction
 Economic instruments are important for water management,
especially when there are notorious supply-demand imbalances and
misallocations.
 As markets are seldom available for solving these problems, water
authorities will decide about levels and features of water tariffs in
order to influence behaviour and allocations.
 In deciding about this, information is required regarding how users
value different water services.

5. Multi-sector use and water valuation

6. Importance of cost-benefit analysis
 To reallocate water among
alternative uses or type of users;
 To expand water infrastructure;
 To improve the quality of water;
 To expand the water service to
include sanitation and wastewater
treatment;
 To include water management
actions at the basin level (very
important for IWRM);
These decisions will
generate potential benefits
but also costs for water
stakeholders
The main objective of cost-
benefit analysis is to
appropriately measure and
attribute these benefits and
costs.

7. Water valuation and economic instruments
 Even if a market is not in place for water service, demand and
WTP exist and reflect how much are the water services valued
by users.
 Costs are the value of the opportunities or resources foregone
in the process of generating the benefits.
 Challenge for valuation methods is how to measure benefits
of water services given situations in which there are not
observable markets or prices for those.
 Equally important are correct estimation of costs and
appropriate levels of tariffs to be charged directly to main
beneficiaries.

8. Demand function and residential use (1)
 Close to be a private good but under monopolistic provision
 Demand can be estimated looking at consumer behaviour and tariff
changes:
Qw = Qw(Pw,Pa,P;Y;Z)
where
Qw: the individual’s level of consumption of water in a specified
time period;
Pw: price of water;
Pa: price of an alternative water source;
P : average price index representing all other goods and services;
Y : consumer’s income, and
Z : vector representing other factors, such as climate and
consumer preferences.”

9.  Demand is estimated using econometric methods applied to
data from water use, tariffs and local and users´ attributes.
 When this type of data is not available (or for new projects),
hedonic price methods and contingent valuation methods are
also used
Demand function and residential use (2)

10. Hedonic price estimations
 Although there is no market for a water service to be evaluated, there
are other markets in which these benefits are embedded (for instance,
real property transactions near an water aesthetic place will somewhat
incorporate these benefits, although bundled with other attributes of the
property).
 This method is based on the assumption that the price of a marketed
good is a function of its different attributes, and an implicit price exist
for each of these.

11. Travel cost methods
 Most amenity and recreational water sites charge
a fixed entrance fee to users, there is no variation
according to demand for those services.
Estimation of demand is problematic.
 Travel cost incurred by visitors is an indirect way
to estimate this demand since there is variation
among visitors in travel expenses.
 When this is possible (using special surveys, for
instance) a demand can be inferred giving a
measure of total benefits generated by the site.

12. Contingent valuation methods
These methods have become very
popular to estimating the values of
water related goods for which there are
no markets or when the water service is
to be created.
Since consumers do not have a clear
idea about the nature of the service,
the researcher has to explain it very
clearly and ask questions regarding the
willingness to pay for these services.

13. Valuation of water as intermediate good
 Often water is not directly consumed but enters a
productive process like agriculture, industry or
hydroelectric power generation.
 Producers will demand an input according to its
marginal productivity.
 When there is no market for the input, like for
water, special methods of valuation are needed:
• Hedonic price method (when a surrogate market can give
information on MVP of water);
• Residual imputation approach and
• Alternative cost approach.

14. Residual method for water valuation
 Is the most-frequently used, particularly to irrigation water.
 Uses a production function approach.
 A total production function is estimated and the marginal
contribution of all relevant inputs (including water) are estimated
with production data and prices for the non-water inputs.
 If these prices correctly reflect their scarcity (well working
markets), the remainder of total value is considered the
contribution of water to total value

15. Think about it
 How useful are water valuation
methods for designing water pricing
policies?
 Do you have in your countries human
and financial resources to make water
valuation studies? Which studies seem
more useful for policy applications?
 What is needed to value water at the
source from water values at each
sectoral use?

16. End
Chapters 1-3 have introduced IWRM and the
need for economic and financial
instruments. For them to be effective,
contributing to sustainability, and
improved access to basic services, they
need to be applied.
Their application will be examined in the
next two chapters.