Hydro-economic models represent the hydrologic, engineering, environmental and economic aspects of basin scale water resource systems in an integrated framework that accounts for the economic value of water services generated. Hydro-economic modeling can be traced back to the use of water demand curves developed in the 1960s and 1970s by Jacob Bear and others. Most hydro-economic models share basic elements including spatial representation of hydrologic flows, water supply infrastructure, supply costs and constraints, economic demands, and operating rules affecting water allocations. Basin-wide hydro-economic model application involves five basic steps: 1. Development of a node-arc model framework incorporating water suppliers and demanders as nodes, and supply and demand linkages as arcs. 2. Development of marginal water supply-cost and demand-price functions for supply and demand nodes, and conveyance-cost functions for model arcs. 3. Calibration of the baseline model using basin hydrologic and water budget data. 4. Development of model scenarios by modifying baseline model variables to represent alternative water resources plans. 5. Evaluation of scenario results to generate policy insights and reveal opportunities for improved water resource planning. Two basic approaches exist for hydro-economic modeling. The holistic approach combines hydrology and economic optimization into a single model. The modular approach involves a transfer of exogenous supply and demand information from an independent hydrologic model to an economic optimization model. For basin scale studies, the modular approach is generally preferred because it allows for more robust and realistic representation of basin hydrology and more efficient optimization of a basin-wide network of water supply and demand nodes.
