increasing marginal utility water drought

Is the Price Right?

by Elaine Schwartz    •    Oct 25, 2013    •    607 Views

Let’s play an economic version of “The Price Is Right.”

Is the price right for flood insurance?

NY’s Senator Chuck Schumer wants the federal government to continue subsidies for flood insurance. As with all subsidies, federal aid has meant lower insurance prices. But now, if the Congress decides to end the price supports, insurance rates would soar while home prices will sink.

Flood insurance price supports from the federal government buoyed home values and fueled home building in flood plains. Now, they will give much needed help to family finances that were decimated by Hurricane Sandy repairs and rebuilding. If discontinued through the Bigert-Water Flood Insurance Reform Act, families could face an extra $15,000 insurance expense for homes that would become unsellable. As a result, living in flood prone areas would become less desirable.

Is the price right for Southern California water?

Averaging 13 inches annually, southern California rainfall is close to desert conditions. But sparse rainfall is not the only reason for water shortages. If you compare areas in Australia with similar conditions, water use is considerably less:

 

From: California Water Blog. 2005 data.

From: California Water Blog. 2005 data.

 

One reason is cheap water. At 25 cents a gallon (2005), a rate that results from government subsidies, California residents had little financial incentive to conserve. They can enjoy plush lawns, long showers, multiple flushes. Even when one person decides to use less water, like the fallacy of composition, she has little impact unless everyone behaves similarly.

Explaining water shortages, one economist tells his classes, “True, it doesn’t rain water in southern California, but it also doesn’t rain Mercedes Benzes in the area either, and neither does it rain Snickers candy bars, or any other good of value. Have we ever had a Mercedes Benz crisis in Southern California?

Our bottom line? The message that prices convey creates incentives. For coastal region insurance where there is too much water and in Southern California where there is too little, lower prices convey misleading information and perverse incentives.

For coastal region insurance and Southern California water, is the price right?

Sources and resources: The NY Daily News tells more about the impact of higher insurance premiums on coastal region homeowners while Richard McKenzie’s Why Popcorn Costs So Much at the Movies and Other Pricing Puzzles provides an excellent discussion of Southern California (also, the source of my quote) water shortages. Comparing California and Australian water use, this California water blog and this paper provided details and my graph.

This entry was slightly edited after it was posted.

And then, an article surfaced in WSJ, “Sandy’s Legacy: Higher Home Prices” that contradicted other sources saying real estate would become less valuable.

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