I'm going to do some supply and demand
analysis for water water subsidies and
water price controls this is also going
to use a few graphs let's start by
drawing a supply and demand graph for
water on the vertical axis we have P
which means price and on the horizontal
axis we have Q which means quantity
there's a supply curve which slopes
upwards that means that at higher prices
people are more willing to sell water
there's a demand curve which slopes
downwards and that means at higher
prices people don't buy as much water we
have a point of market clearing which
you can see here it means in this
equilibrium there's a market price given
on the vertical axis and there's a
quantity bought and sold given on the
horizontal axis in a very basic setting
there are some efficiency properties to
this market price and market quantity
for instance assume that the production
of water were to be extended to the
right along this diagram past the point
of market equilibrium so rather than
producing water here we would be
producing water say somewhere out here
what would then be the case if you look
at the point on the demand curve that
tells you how much is the value of water
to the demanders if you look at the
point on the supply curve that tells you
how much it's costing to supply that
water and to be producing water out here
to the right it would imply that it's
costing more to supply that water than
people value that water and that would
be inefficient it means we're using too
much water and we're using up water too
rapidly we would rather be back here at
the point of market clearing now enter
the water subsidy a lot of governments
make it artificially cheap for
individuals in that country to use water
the water subsidy may apply directly to
water but sometimes the water subsidy is
indirect and it takes the form of a
subsidy to agriculture in a typical
country agriculture will consume sixty
to eighty percent of the water needs so
if agriculture is being subsidized that
means that indirectly water is being
subsidized to for the water subsidy
let's go back to our supply and demand
curves price on the vertical axis
quantity on the horrors
bothell the supply curve slopes up the
demand curve slopes down how we graph
this depends on the exact form the
subsidy takes but one simple way to
think about it is to imagine that the
subsidy shifts the demand curve out and
to the right that means that at any
given market price people wish to buy
more water because they're purchased is
being subsidized by the government
remove from a state of affairs where
people were buying this much water to a
state of affairs where they're now
buying this much water but they're
actually buying too much water and week
we can represent that quantity
difference below the demand curve which
is further out to the right it does
represent higher demand for water but it
doesn't represent higher social value
for that water the demand is higher only
because people are getting the subsidy
and that subsidy of course is taken away
from others somewhere along the line so
the real social value of water is given
by this initial demand curve the social
cost of the subsidy is given by this
triangle here an economist's call that
deadweight loss it represents the fact
that after the subsidy people are buying
the water with an artificially inflated
demand curve which is not reflecting
true social values if you think of all
of these points here what we're seeing
is that the social cost of those
additional units of water is higher than
the actual social value so again too
much water is being put on the
marketplace and water resources are
being used up too rapidly the subsidy
makes the private value of buying the
water higher than the social value of
supplying the water in the developing
world often water use is not metered
this means that at the margin you can
use more water and you don't have to pay
for it in terms of the demand this will
make the demand very high but in terms
of willingness to supply well the
businesses who supply watterson think
since they can't charge more for
supplying extra they're not so keen to
supply more this will bring about a
problem let's go back to our supply and
demand graph again we have price on the
vertical axis quantity on the horizontal
axis a downward sloping demand curve and
upward sloping supply
Irv and now if there are no meters in
essence at the margin what's the price
of water it's going to be zero supply
will be here demand will be here there's
a big gap between how much people want
to buy of water and how much water will
be supplied and that is the size of a
water shortage and that all comes about
because at the margin water is not being
priced because in this case there are no
water meters there are other forms of
water price controls imagine for
instance there simply a law saying that
water cannot be sold for any more than
this price we can then draw across the
quantity of water supplied is this
amount the quantity of water demanded is
this amount and again we have a shortage
of water given by the difference between
desired quantity demanded and the
quantity of water which suppliers are
willing to put on the market there's
another interesting feature of these
kinds of outcomes when the price is too
low there are more people wanting to buy
mortar that water then there will be
water supplied so that water somehow has
to be rationed or allocated often its
allocated in terms of political
privilege who has the pole with the
government to get the permits or the
licenses or the access to water in a
market setting the people who get that
water are the people willing to pay the
most for it or the people who in
economic terms value that water the most
when there's a price control this means
that who gets the water has more to do
with politics and it may or may not be
the people who actually value the water
most in economic terms this is a
potential inefficiency namely that the
people who are getting the water are not
the people who value the water most in
economic terms this is one reason why
economists typically favor tradable
water rights let's say we're in a
situation where the people who are
getting the water through whatever
mechanism are not the people who value
the water most in economic terms if
those water rights are tradable the
people who get the water will trade that
water and those water rights to people
who value the water more that will make
the outcome again in economic terms more
efficient when the water rights are not
tradable we are stuck with the people
owning or using the water being the
people who are not those who value the
water most
to sum up these are some basic settings
in which markets for water prices for
water and the trading of water rights
help bring about more efficient outcomes
this analysis does not take into account
all of the complexities of water markets
or all of their social ramifications but
think of it as a very basic starting
point for understanding some of the
things which can go wrong in regulated
water markets subsidies can cause excess
water use and price controls can cause
in adequate water supply