Modeling Conjunctive Water Use as a Reciprocal Externality

Garth Taylor, Robert D. Schmidt, Leroy Stodick and Bryce A. Contor

American Journal of Agricultural Economics, 2014, vol. 96, issue 3, 753-768

Abstract: A reciprocal externality is created in the conjunctive use of hydrologically connected surface and ground water. Hydrologic and economic modeling are integrated to conduct basin-wide cost benefit analysis to address the market failure of reciprocal conjunctive use externalities. An n-node partial equilibrium model was formulated in which economic equilibrium was defined by a system of complementary slackness equations. The general model was applied to a three-node example of a ground water pumper that enjoys the positive externality of canal seepage while inflicting a negative externality of pumping-induced seepage upon a canal water user. Exogenous demand, supply, and canal conveyance variables were parameterized using site-specific functional forms and data. The example was solved using mixed complementary programming for the endogenous equilibrium water prices which in turn were used to calculate consumer and producer surplus in the respective surface and ground water markets. A Pigouvian tax/subsidy policy was contrasted against two real-world policies; eliminating the externality through conservation infrastructure and aquifer recharge. The Pigouvian tax/subsidy aligns prices to erase the wedge between social and private costs. The reciprocal externality produces feedback between the surface and ground water markets that reinforces or cancels the tax/subsidy effect. The recharge payment prices canal seepage via a payment from pumper to canal user that matches the decrease in total pumping cost attributable to the seepage resulting from canal diversion. The Pigouvian tax/subsidy yielded the highest social welfare, followed by the aquifer recharge payment. Conserving water by lining the leaky canal decreased social welfare.

Date: 2014
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