The Use of a Water Market to Minimize Drought‐Induced Losses in the Bay Area of California

Abstract

In the Bay Area of California, a collection of utilities must determine how to allocate a shared resource during drought. If they choose to use market principles, the market price for water will be determined by the total demand for water, which is dependent on the elasticity of demand for water for each utility. The elasticity of demand for water has proved a difficult metric to estimate, involving considerable uncertainty. This work, rather than trying to use a single estimate of elasticity for each utility, uses Monte Carlo simulation to evaluate a market using a range of elasticity values. The use of a market is shown to reduce economic losses by at least 25%, compared with the current nonmarket allocation. The robustness of the benefits shown by the market, even with the inherent uncertainty in elasticity values, may inspire confidence in policymakers to adopt more market‐based allocation strategies.