Optimal Water Use: A Matter of Giving the Right Incentives

This paper discusses some widespread inefficiencies in water pricing today, contrasting prices for domestic and agricultural users. Solving the “planner's problem” I am able to conclude that water for irrigation should likely cost much more than for domestic use. I apply this analysis to water use in California. Current inefficiencies there arise not only because levels of prices are suboptimal, but also because relative prices for agricultural and domestic users are misaligned, since they do not take into account the effects of different users on future scarcity. The welfare gains associated with correcting these prices appear to be significant.