Consumer Surplus Under Uncertainty: An Application to Dam-Reservoir Projects

The use of cost-benefit analysis to evaluate the net welfare payoffs from water projects has now been an established practice for many years. One of the interesting aspects of such cost-benefit studies is that water projects involve an uncertain flow of costs and benefits, arising from the stochastic nature of streamflows. Hence a basic problem for the cost-benefit analyst is that of incorporating this uncertainty into his measures of costs and benefits. In the present paper, we examine the problem of computing an appropriate consumer surplus measure to evaluate water project benefits under uncertainty. Detailed treatment is given to the case in which a complete set of contingent claim markets exist in the economy, as well as to the case of a spot market economy.