Question

During periods of drought in California, the State Water Resources Control Board oversees the allocation of scarce amounts of water. One of the most controversial aspects of California’s water policy is historical water rights given to farmers with rights predating 1914. Agriculture accounts for 80% of water consumption in California but only 2% of economic activity. In fact, more water is used to produce almonds in California than is used by all the residents and businesses of San Francisco and Los Angeles combined.Some policymakers have proposed eliminating water rights permits that allow farmers to use creeks, rivers, and groundwater to irrigate their crops at no cost in favor of pricing water rights in a single state-wide free market where municipalities, farmers, and households would be able to bid for water rights.

1. Would this change be a Pareto improvement? Explain.
2. Would this change increase the total social surplus? Explain.

Are there any other considerations that you would recommend policymakers consider in deciding whether to switch to a state-wide market for water? Explain.

Answer 1

(a) The situation would not be a pareto improvement. A pareto improving situation is one where no one loses while some individuals gain with the new situation. Since the recommendation is that the individuals bid for water rights as opposed to the previous situation where the farmers were assigned the initial rights on water. This means that in the new arrangement, farmers will have to bid for the rights which makes them worse off than before.

(b) The change in total social surplus depends on if whether the loss in farmer surplus is more or the gain of the society surplus. If the loss to farmers is more then the total social surplus reduces but if the society gains are huge than they can offset the loss to farmers, in such a case the total social surplues increases.

The policy makers should compare the costs and benefits associated with the decision of switching to a state wide market for water. The benefits of this action could include the increase in economic activity with optimal usage of water because the highest bidders would be those who value it the most. The costs on the other hand would be the additional costs that the farmers have to bear to bid for water. There is also a possibility that the contribution of agricultre may go even lesser than 2% without free access to water, this cost has to be borne by the society as a whole. If the benefits outweigh the costs, then they should proceed with the decision.