Price Differentials in a Homogenous Product Market: The Case of Water
Yoskowitz, David W., International Advances in Economic Research
DAVID W. YOSKOWITZ [*]
This paper examines the existing price differentials for raw water along the Rio Grande. An extremely active spot market for this good, more than 926 transactions have been made over a five-year time period. Statistical analysis shows a significant difference between the price paid for water by irrigators or municipalities and industry. Even if price differentials did exist at the beginning, convergence would be expected over time for this homogenous good. However, statistical analysis shows no sign of convergence. Investigations have suggested that differentials may continue to exist due not to the lack of information, but to misinformation. (JEL L10)
Price differentials for ostensibly homogenous products are more common than microeconomic theory would have us believe. These differentials may exist for several reasons, which include informational and spatial asymmetries. However, it is difficult to understand why price differentials would continue to exist if these asymmetries were absent from the market.
This paper addresses such a situation for water, specifically, raw water within the Rio Grande Valley, along the Texas-Mexico border, used for irrigation, municipal, and industrial purposes. An extremely active spot market for this perfectly homogenous good had developed in the early 1990s. However, significant differentials continue to exist in prices among buyers and sellers.
The objectives of this article are to:
1) briefly identify the institutional nature of the water market and the activity involved therein;
2) statistically show that price differentials do exist between user groups and there has been no convergence in prices over the period of the data; and
3) present possible explanations as to why the differentials in prices exist.
Along the Rio Grande, terms of market transfers for water reflect the broad-based characteristics of market exchange in general [Jonish et al., 1996, pp. 170-5]. The transfer may be permanent. This involves the exchange of water rights, with or without associated land ownership, from one entity to another on a permanent basis. The sale price represents the capitalized value of the water right over time. The transfer may be on a term or fixed-period basis. The contract price reflects the guaranteed delivery of water per year at a fixed price for the specified period of years. Transfers may be spot market transfers, that is, a one-time exchange of a quantity of water from seller to buyer. The transfer price here should reflect prevailing conditions at the time (drought or abundance) of transfer.
The most active of these markets is the spot. There are several reasons why this is such an active market. First, transactions can easily take place. A buyer need only make a few phone calls to find a seller and conduct the transaction. Since this is not a permanent transfer of the water right, there is no need for regulatory approval of the transaction.
Second, the market is broad. With more than 813 active water rights along the Rio Grande, there are a large number of potential buyers and sellers of spot market water. Therefore, it is highly likely that water would always be available for this type of transaction. Third, individuals (municipalities, irrigators, and industry) who find themselves needing additional supplies can obtain them through this simple mechanism without the added complications of a permanent transfer.
The institutions responsible for regulating water usage along the Rio Grande are, in large part, responsible for the active spot market. The Rio Grande watermaster (RGW) office is charged with monitoring the use, allocating the water, and enforcing those water rights laws and regulations established by the Hidalgo decision [State of Texas v. Hidalgo, 1969; Schoolmaster, 1991] and the Texas legislature. …