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UW-Milwaukee - Center for Economic Development

Policy Research Working Paper Abstract

Microeconomics of Reliable Urban Water Supply: The Comparative Economic Advantage of Great Lakes Cities, May 2010, by William L. Holahan

Executive Summary

This paper presents some of the elements of microeconomics that are valuable in formulating water policy in older cities along the Great Lakes. In their heydays these cities installed capacity in anticipation of greater economic activity than they now have. Now they face decisions on water pricing, sales to suburbs, and the use of water as an economic redevelopment tool.

Not surprisingly, economists analyze water using the tools of demand and supply. Some demands for water are for essential uses; other uses are more discretionary. Demand elasticity differs for different uses but is generally far less than one, indicating that revenue increases as price rises. Non-linear marginal-cost pricing of water permits separation of the relatively more essential (low volume, low demand elasticity) uses of water from the more optional (high volume, higher demand-elasticity) uses of water. On the supply side, many sources of water are shared in "common" and therefore unregulated markets will tend to deplete and degrade sources of water at rates greater than the efficient rates. Efficient prices would cover not only infrastructure costs but also the costs of common pool externality and of depletion and degradation.

Reliable water supply serves as a comparative advantage for older cities, a major attractor for business growth as other parts of the country increasingly suffer drought. Because the demand for water is inelastic, the city can increase the revenue from water sales by raising price. The increased revenue can be used to foster a broad mix of economic activity such as a cut in city tax rates to attract or retain residential and business activity or to provide other growth policy inducements such as tax-incremental financing for start-up firms. Moreover, the greater revenue derived from higher prices provides a more flexible economic development tool than reduced prices for water.

 

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