The Full Economic Cost of Groundwater Extraction

When a groundwater basin is exploited by
a large number of farmers, acting independently, each farmer
has little incentive to practice conservation that would
primarily benefit other farmers. This can lead to excessive
groundwater extraction. When farmers pay less than the full
cost of electricity used for groundwater pumping, this
problem can be worsened; while the problem can be somewhat
relieved by rationing the electricity supply. The research
in this paper constructs an analytical framework for
describing the characteristics of economically efficient
groundwater management plans, identifying how individual
water use decisions by farmers collectively depart from
efficient resource use, and examining how policies related
to both water and electricity can improve on the efficiency
of the status quo. It is shown that an optimal scheme for
pricing electricity used for pumping groundwater includes
two main elements: 1) the full (marginal) economic cost of
electricity must be covered; and 2) there must be an extra
charge, reflected in the electricity price, corresponding to
the externality cost of groundwater pumping. The analysis
includes a methodology for calculating the latter
externality cost, based on just a few parameters, and a
discussion of how electricity pricing could be modified to
improve efficiency in both power and water use.