Tuesday, July 11, 2006

Supply curves slope upward 

Reader Eva Young sends along a story about the use of water in making ethanol. The concern is, we might use too much water.
With so many plants on the horizon and water shortages possible, the state is ramping up warnings to companies to be extra careful about choosing where to build. Preventing future water depletion ensures plenty of water for everyone, including the public and small businesses.

"We want to make sure people address their water supply before they locate the plant," said Jim Japs, assistant director of the Minnesota Department of Natural Resources' waters division. "If they don't have enough water, they are not going to be able to operate."
The story has been over the AP wire as well, and I say it's silly. People have been buying up stills to make ethanol for more than a year now. Why? Because the price of gas goes up, and in the long run this encourages people to create substitutes like ethanol. So of course they demand things to make the ethanol, of which water is one. What determines whether water is more valuable keeping my grass green or making ethanol? Price. If these plants come on line, a market for water would lead to increased price of that input; in economic terms, an increase demand for water increases price, and you move along the water supply curve. As the price rises, ethanol manufacturing profits decline and reduce demand for these plants.

But something else happens too. A rise in the price of water lowers how much water I put on the yard, or my desire to enjoy a nice summer night by washing the car in the driveway, or... Think of all the uses we have for water. Each of them has a substitute activity, including dirty cars and brown lawns. Each of those substitutes becomes desirable at some price. That's how markets work. Let's hope the MnDNR agrees to let markets do their thing.