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California Water Pricing Strategies
Abstract
The paper reviews the effect of marginal cost pricing to agricultural and residential consumers of water. It previews the background of marginal price costs in California and costs applicable to consumers. Further, the effect of size of acre-foot usage of water and substitute inputs for production against water costs, as used in production are described. Finally, there is a market analysis of the selected products found on extreme sides of study objectives.
Keywords: marginal price cost, agricultural users, residential users, market analysis
California Water Pricing Strategies
Questions-Answers
1. Summarize the current situation and problems associated with California water pricing strategies.
The use of water in California is controlled by the State. The State has major control of water sale and transfer. The involvement of state was a result of continued conflicts over water due to the older system that placed exclusive rights of water on the owners of property, where water points were located. The existing framework limits conservation of water and its transfer to people who can make a better use out of it.
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About 85% of water from the California State is used for irrigation. The supply chain is composed of delivery agencies, retailers and wholesalers. The wholesalers get water from federal, state and local sources for average prices of $10, $60 and $100 per acre foot. Retailers have no definite prices but often intend to cover their costs. In States dominated by farmers, residential users pay for water more than farmers do. As a result, the amount of money paid by agricultural users is close to the marginal cost in the state, if not lower. Water districts, on the other hand, are not allowed to make any profits from the sale of water. They are urban and agricultural water districts. The pricing of water in each basin is considered as uniform, even though various crops have different water use requirement. Such requirements vary from 1% to 35.8% more with the crop populations (Robyn, 2014).
2. How would implementation of a marginal cost pricing system for water impact total agricultural consumption and total urban consumption of water in California?
The price of a commodity has a fundamental effect on the demand and supply of a commodity. As it was already noted above, retailers always pass the costs to their consumers. Thus, retailers cover all the costs related to the water supply. When the marginal cost of water increases, there is an increase in the price of water. This is caused by the fact that retailers of water explicitly adopt a method of entirely covering the cost. In the event of an increase in marginal cost, retailers either increase their price or otherwise watch the marginal cost eat into their profits. It is done with an assumption that the market is fixed, such as for agricultural users and residential users in a district. An increase in the price of water lowers the total agricultural consumption by increasing the costs of production, while reducing the consumption in residential. On the contrary, if the marginal cost is lowered, a residential consumer will be the greatest winner, especially if the cost is reviewed to close or equal to the marginal cost of districts. Farmers will experience the same cost, since the marginal cost extended to them is on average equal to the marginal cost in districts. Residential consumption increases, while agricultural consumption remains fairly constant (Arnold, 2010; Schmitt, 2002).
3. How would implementation of a marginal cost pricing system impact the markets for agricultural crops?
The answer selects grain hay that has 35.8% factor of water as a part of its total production cost. As a result, an increase in the marginal cost translates to increased costs for agricultural producers. Before an implementation of the increase of marginal cost way above the district marginal cost, the producer of grain hay produced 30,000 units at a market of price $4.5, see figure 1(Arnold, 2010; Schmitt, 2002).
Figure 1 shows the equilibrium market for grain hay before and after an increase in marginal cost of water.
The increase in marginal cost interferes with the equilibrium market price. The average cost increases and shifts the price to a new point P, where revenues meet to set a new equilibrium. After the increase of marginal cost, a producer of grain hay decides to increase the unit price of grain hay by passing the additional costs to consumers to protect their profit margins. Similarly, the number of units produced reduces by 5,000 to 15,000 units, as displayed in figure 2. The increase in the marginal costing reduces supply of grain by increasing the cost of production. The increase in marginal cost shifts the equilibrium demand and supply to the left and reduces the surplus production (Brux, 2011).
Figure 2 shows the changes in demand and supply (equilibrium market) due to changes in the marginal cost of water.
4. Evaluate which types of farmers (in terms of the crops they grow) would face the largest increases in production costs if California water pricing strategies are reviewed to consumption relative to production?
i. Farmers will experience the highest increase in water prices per acre-foot, as indicated in Exhibit 5. The use of water here is a function of land coverage, thus crops that cover more land attract a higher marginal cost (Robyn, 2014).
Lettuce
Carrots
Celery
The following farmers will experience the lowest increase in water prices per acre-foot
Irrigated pasture
Rice
Walnuts
ii. The following farmers will experience the highest increase in water prices, based on the share of water used in production. The cost of water here is a function of water usage, such that water is a great component in the total cost of production. The crops as outlined in Exhibit 6 (Robyn, 2014);
Grain Hay
Irrigated Pasture
Alfalfa hay
The following farmers will experience the lowest increase in water prices, based on the share of water used in production.
Pears
Peaches
Celery
iii. The following farmers have the highest ability to substitute water usage with other inputs. The substitute variation indicates water usage, as compared between farmers for the crop. The crops are as outlined in Exhibit 8 (Robyn, 2014);
Onions
Pear
Grain Hay
The following farmers have the lowest ability to substitute water usage with other inputs.
Melons
Rice
Lima Beans
a. Comparison of lettuce, rice and prune farmers.
Based on price increase for water by crop as a function of acre per foot, lettuce bears the highest costs at $80 followed by prune and rice at $40 and $30, respectively. Lettuce is the most affected of the three crops. As a result, it will have the highest cost increases, while rice will have the least cost increase. If the average share of water per crop is factored in for the crops, rice leads at $19.7, followed by lettuce and prune at $4.7 and $4.3, respectively. Usage fronts rice to exhibit the increase in costs, followed by lettuce and prune. Finally, with reference to exhibit 8, where water is a substitute to other inputs as base comparisons to usage amidst farmers, the input ratios are ranked for prunes, lettuce and rice, respectively. In this case, the costs for rice are likely to remain stable because the substitutes bear the smallest index. Prune, on the other hand, has a greater index within which substitute input can be factored to lower the cost of production. If all the factors are factored in, lettuce and prune experience most adjustable costs to absorb changes in costs due to large degree in manipulation of substitute inputs. The farmers of these crops can seek alternate production model to reduce costs, unlike rice farmers (Robyn, 2014).
5. Comparison of melons and pears supply curves.
The production of melons as a share of production in the United States from California State is 306,500 tons that comprises of about 63.8% of the total share of melon produced in the United States. On the other hand, California State produces 300,400 tons of pears that is 5.4% of the total share of total share of pears produced in the U.S.
Ideally, an increase in the cost of production reduces production by making the cost of production higher, thus supply shift from S1 to S2. The price of melons slightly increases in comparison to that of pear, since its proportion of production to the U.S market is small, hence is taken by about 94% of the existing market share. There will be many suppliers attracted from States due to higher prices. Hence, the price will reduce slightly. Melons command greater proportion of production in the U.S. Californian market and is, therefore, a market leader. The prices of melons can increase with the same proportion of an increase of the marginal cost. Melons production from California stands at 63.4%. There is a greater market gap for other producers of melon and/ or substitutes, hence the great price increase (Robyn, 2014; Arnold, 2010).
