Water into Wine and Cheese: Implications of Substitution and Trade for California’s Perennial Water Woes

Water woes are growing globally as farmers and others struggle to develop infrastructure and institutions that allow the agricultural economy to thrive in the face of competing uses for water. While not new, these struggles are deeply important, and nowhere more so than to agriculture within arid regions. This chapter uses the California water context to trace through the simple economics of how irrigation water availability and price affect prices and quantities of tradeable food products. We highlight a few key relationships within the supply chains for wine and cheese using the simplest framework possible—fixed proportions and elastic input supplies at each stage of a multi-market chain. First, we consider irrigation water used to produce grapes that are transformed into wine and highlight the role of cost shares and final product demand elasticities. We show that irrigation water is a far more important driver of prices and quantities in the low-cost San Joaquin Valley region, which faces a more elastic demand for wine than in the high-cost (and price) North Coast region, which faces a less elastic demand. When we consider the irrigation water used to produce feed crops for dairy cows—which, in turn, produce milk that is transformed into cheese, we find that water has only a moderate cost share in forage production and that forage has a moderate share in milk output. Nevertheless, because California cheese faces an elastic demand in the global market, a rise in water costs could reduce California cheese production significantly.