The Economics of Groundwater

We provide a synthesis of the economics of groundwater with a focus on optimal management and the Pearce equation for renewable resources. General management principles developed through the solution of a single aquifer optimization problem are extended to the management of multiple resources including additional groundwater aquifers, surface water, recycled wastewater, and upland watersheds. Given an abundant (albeit expensive) substitute, optimal management is sustainable in the long run. We also discuss the open-access equilibrium for groundwater and the conditions under which the Gisser-Sanchez effect (the result that the present value generated by competitive resource extraction and that generated by optimal control of groundwater are nearly identical) is valid. From the models and examples discussed, one can conclude that optimization across any number of dimensions (e.g. space, time, quality) is driven by a system shadow price, and augmenting groundwater with available alternatives lessens scarcity and increases welfare if timed appropriately. Other rules-of-thumb including historical cost recovery, independent management of separate aquifers, and maximum sustainable yield are inefficient and may involve large welfare losses.