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1) The figure (at 3:00) is WRONG. A subsidy does NOT shift the D curve; it closes the wedge (shown in the first drawing of the fig, where Q was greater but P_d was less than P_s).
2) Most agricultural water (esp. groundwater) is "own supply" and the subsidies are more complicated (e.g., opportunity cost due to some having a RIGHT to water)
3) Most urban water is sold at average, not marginal, cost, which means that the utility ends up supplying water at prices that are below the cost of production. HUGE problem.
4) The scenario in your fig (at 5:45) does not always happen, since fixed revenues can be used to subsidize marginal costs of production. The FC/VC vs FR/VR issue is very important in water economics.
5) But you're RIGHT about who gets water (powerful) w price controls.
6) Don't confuse water tariffs (retail service) with water rights (wholesale markets). They are totally separate.
Don't fixed and variable costs come into the picture? Following the Walkerton e coli tragedy water became metered. Over the next ten years, water usage has continually gone down and water rates have continually gone up to cover the fixed treatment, maintenance and salary costs. What happened to the economy of scale argument presented for watermelons?
Yes, FC and VC matter. Most people miss that, but the "problem" results from FC NOT matching FR (monthly charge) at utilities. That's why you get the problem you noted. Here's my soln: http://www.aguanomics.com/2011/09/time-to-dump-increasing-block-rates.html
The subsidies to agriculture, that amounts to 75% of water consumption, mean subsidies to water, with all the misallocation of resources and loss of welfare implied. That's an important point! Half the budget of the European Union goes to fund the Common Agricultural Policy. A complete folly and insanity.