The value of ground water, that is, its ability to produce valuable service flows to people, is increased when any given amount of water is allocated efficiently across potential water uses. Water is efficiently allocated when the increment to value that could be obtained from using a little more water in any one way (called the marginal value of water in that use) is the same across all uses of water. To understand this concept, assume that such a balance does not exist. For example, suppose that one use (say, an industrial process) could generate $100 in incremental value if a little more water is used there, while another use (say, agricultural production) would lose only $50 in value if a little water is removed from that use. Then transferring a unit of water from the agriculture to the industrial use increases the total value of water services by $50.
Any inefficiencies in the allocation of ground water across uses or quality will lower the value of the ground water. Poor quality will also reduce its value to users. The value of ground water, then, is intimately tied to institutions that govern how it is allocated (or misallocated) and protected in the current period, through time, and according to its quality. That is why, in Figure 3.1, institutions are depicted as a set of overarching influences that govern the value of ground water.
One possible institution for allocating ground water is a set of private water markets. Economists have shown that if these markets are organized in a particular fashion, then the allocation of water among uses will be efficient. Of course the conditions underlying this result would be difficult to meet. Instead of a market system, there presently exists a complex web of water resource institutions that vary from jurisdiction to jurisdiction. These institutions are described in more detail in Chapter 5. The analysis of how these institutions promote or mitigate inefficient water allocations is an important but difficult task that is beyond the scope of this committee's investigation.
The total value of ground water is increased if it is efficiently allocated. Identifying this efficient allocation depends on measuring the incremental value of water in alternative uses and the incremental value of improvements in water quality. When there are large gaps between these incremental values across uses, then economic well-being is enhanced by altering the allocation. If the incremental costs and benefits of changing water quality are greatly different, then economic well-being is enhanced by improving water quality or perhaps by allowing a lower level of water quality for some uses.
Consider first the allocation decision. In Figure 3.2 the horizontal axis shows the quantity of water that can be allocated to either of two uses: in-stream flows, which provide ecological services; or landscaping, which provides aesthetic values that can also be considered a part of ecological services. At the right edge of the diagram, at point Q, all water is allocated to in-stream flows, and none goes to landscaping. The vertical axis measures incremental values. The line