OPTIMAL MANAGEMENT OF GROUNDWATER OVER SPACE AND TIME

For nearly half a century, groundwater has been portrayed in the economic literature as a typical common property resource. Numerous studies of groundwater extraction have analyzed the externalities imposed by users on each other. A large body of work offers clear prescriptions in the form of optimal policy instruments, and a similarly large body of work advocates the needlessness of any centralized intervention. Yet existing theoretical models of groundwater extraction implicitly make two strong assumptions about the underlying behavior of the resource. First, the spatial distribution of resource users is assumed to be irrelevant. Second, path-independence of the resource is assumed: the history of past extraction does not affect present and future extraction decisions. Relaxing either of these assumptions may undermine the results of existing work. The purpose of this chapter is to present a model for the extraction of a path-dependent resource by spatially distributed users. The example of groundwater is used to demonstrate the incorporation of the physics of a complex natural system into an economic model of dynamic resource use. In particular, the optimality conditions can be calibrated to parameters found in actual aquifers to model the range of behavior encountered in the real world. This demonstrates the failure of existing models of groundwater extraction to describe aquifers adequately