A framework for valuing water demand management: Literature review

Nicola Smith, Gary McDonald, Susie Trinh.

This is report 1 of 3 in a rigorous economic analysis of the value of water demand management to help councils and water authorities to demonstrate the value of such an approach to decision-makers and communities.

Many water values, like those of other ecological resources, are not easily captured by regular market mechanisms and water is often regarded as a common good. This applies particularly in regards to the indirect use values provided through water’s role in the provision of ecosystem services, such as waste treatment and nutrient cycling, and also in regards to the non-use values provided by water. Even in regards to direct use values, typically the type of values most amenable to market valuation, there are a number of characteristics which make water difficult to effectively price and allocate.

A variety of methods have been developed to ‘internalise the environment’ in economic valuation exercises, with most implicitly adopting an opportunity-cost framework. This process requires estimation, usually in monetary terms, of the ‘opportunity cost’ by assigning monetary values to improvements (or reductions) in ecological goods and services. A variety of techniques can be applied in these regards depending on the type of value in question, for example developing demand functions for municipal water use, alternative cost methods and hedonic pricing methods. Various limitations are associated with each technique.