Strategic entry and externalities in groundwater resources: Evidence from the lab

This study uses economics experiments to extend the literature on common-pool resources by focusing on entry investment behavior in a stylized, spatially explicit aquifer. The model consists of a two-stage game, where participants make an entry decision in the first stage and, if they choose to enter, decide how much resource to extract in the second stage. Results show that entry behavior and groundwater pumping decisions are significantly affected by the underlying spatial externalities of the resource. In instances where the impacts of groundwater use are spread across all resource users, we observe both a greater number of users choosing to use the resource and a higher intensity of use. The results support expectations from the model that groundwater management policies should focus on entry in addition to decisions related to the volume of pumping. The results also discern the interplay of entry with both hydrogeologic characteristics of the resource and the option to exit and reveal that the option to exit increases the intensity of extraction as well as initial entry rates.     

Privatization of Water-Resource Development

This paper analyzes the inefficiencies from market power and return-flow externalities in private construction of a water project. The model pays special attention to increasing groundwater pumping costs, project set-up costs, limited project capacity, and return flow to the aquifer. For a given capacity, the return-flow externality causes project owners to construct the project too late when the price of groundwater is too high because the external benefit of return-flow to the aquifer is not captured. Market power exacerbates these effects since the project owner delays construction to accelerate groundwater overdraft. The return-flow externality and market power also decrease installed capacity and increase overdraft from the aquifer. Applying the model to the construction of the Central Arizona Project (CAP) for a given capacity, the estimated deadweight loss from hypothetical private construction of the project ($0.853 billion) is substantially less than the literature’s estimate of deadweight loss from actual construction by the Bureau of Reclamation ($2.603 billion). However, under the federal subsidies and insecure property rights that accompanied the CAP, private construction results in a larger estimated efficiency loss ($6.126 billion).     

Strategic Behavior and Efficiency in the Common Property Extraction of Groundwater

Externalities that arise from privateexploitation of groundwater are analyzed by comparing socially optimal and privateextraction. Open-loop Nashequilibrium and stationary Markov feedbackequilibrium in nonlinear strategieshave been computed to characterize privateextraction. The use of thesetwo equilibrium concepts allows us todistinguish between cost andstrategic externalities as long as the open-loop solutioncaptures only the cost externality, and the feedback solution capturesboth. The results show thatstrategic behavior increases theoverexploitation of the aquifer. However, ifthe groundwater storage capacity is large, thedifference between the sociallyoptimal and private extraction is negligible.     

Spatial-dynamic seawater intrusion and pumping cost externalities in a confined aquifer

This paper analytically develops the economic theory of seawater intrusion in confined aquifers and, in the process, creates generally applicable solution methods for illuminating steady-state spatial externality relationships for other spatial-dynamic diffusion resource management issues. By linking a confined aquifer and its unconfined recharge region with a dynamic boundary condition neglected in the economics literature, we introduce the physical realities that generate spatial externalities in all renewable confined aquifers. We derive spatial-dynamic first-order conditions for optimal extraction and characterize the policy relevant spatial-dynamic pumping cost and seawater intrusion cost externalities with hydrological assumptions appropriate to the different dynamic timescales of system components and the focus on seawater intrusion. For confined aquifers, we prove the marginal seawater intrusion cost externality decreases linearly in distance from the coast. Moreover, we demonstrate that the marginal seawater intrusion cost externality generally exceeds marginal pumping costs near the coast, implying substantial divergence between optimal and common property extraction near the coast, and significant divergence may extend to the inland aquifer boundary depending on both the magnitude and shape of the revenue function relative to extraction costs and aquifer parameters.     

Renewable resource management with stock externalities: Coastal aquifers and submarine groundwater discharge

We model coastal groundwater management and its effects on submarine groundwater discharge, nearshore marine water quality, and marine biota. Incorporating the stock externality effects on nearshore resources increases the optimal sustainable steady-state levels of both the aquifer head and the stock of a keystone native algae species. Numerical simulations are illustrated using data from the Kuki’o region on the Island of Hawaii. Two different approaches for incorporating the nearshore resource are examined. Including algae's market value in the objective function results in only slightly lower rates of groundwater extraction. When a minimum constraint is placed on the stock of the keystone species, however, greater conservation may be indicated. The constraint also results in non-monotonic paths of water extraction, head level, and marginal opportunity cost of water in the optimal solution.     

Groundwater and ecosystems damages: Questioning the Gisser-Sánchez effect

Gisser and Sánchez (1980a) state the conditions under which welfare gains from policy intervention are negligible in aquifer management, when compared with non-regulation or “free market” outcomes. This is the so-called Gisser-Sánchez effect (GSE), which has been supported by the ensuing literature during recent decades. The GSE requires a number of assumptions, among which is the disregard for aquatic ecosystems linked and dependent on aquifer systems. The depletion of aquifer systems in arid and semiarid regions worldwide is causing acute water scarcity and quality degradation, and leading to extensive ecosystem damages. This study shows that by including environmental damages into the analytical model, results can change substantially. The analysis highlights both theoretically and empirically the importance of policies in groundwater management, as well as the potential role for stakeholders' cooperation. The empirical application deals with two large aquifers in Spain, the Western La Mancha aquifer which is grossly mismanaged, and the Eastern La Mancha aquifer, which is moving towards sustainable management. Western and Eastern La Mancha aquifers illustrate that policies and institutions are essential to avoid the current global aquifer mismanagement.     

Groundwater management under heterogeneous land tenure arrangements

We develop a groundwater extraction model that considers the Marshallian inefficiency associated with sharecropping and use data from Pakistan to simulate the impact of an open access regime and of optimal management on groundwater extractions, the state of the aquifer, and annual net benefits through time. We also evaluate a price instrument as a mechanism of inducing optimal extractions. Under both open access and optimal management, we observe notable differences in groundwater extractions and the water table level between the tenure model (which considers the behavior of both owner cultivators and sharecroppers) and the baseline model (which includes the behavior of only owner cultivators). We also find a modest difference in the aggregate net benefits generated by the two models. The results offer new insights—vis-à-vis land tenure heterogeneity—into the evaluation of more effective policies for groundwater management and aquifer sustainability.     

On the spatial nature of the groundwater pumping externality

Most existing economic analyses of optimal groundwater management use single-cell aquifer models, which assume that an aquifer responds uniformly and instantly to groundwater pumping. In this paper, we develop an economic model of groundwater management that explicitly incorporates spatial dynamic groundwater flow equations. Calibration of our model to published economic studies of specific aquifers demonstrates that existing studies generally incorrectly estimate the magnitude of the groundwater pumping externality relative to spatially explicit models. In particular, for large aquifers with surface areas of thousands of square miles, the marginal pumping externality predicted by single-cell models may be orders of magnitude less than that predicted by a spatially explicit model, even at large distances from a pumping well. Conversely, for small aquifers with areas of a few hundred square miles or less, single-cell models reasonably approximate the pumping externality. Application of single-cell models to inappropriate settings may result in misleading policy implications due to understatement of the magnitude and spatial nature of the groundwater externality.     

Endogenous timing in private and mixed duopolies with emission taxes

This paper examines an endogenous timing game in product differentiated duopolies under price competition when emission tax is imposed on environmental externality. We show that a simultaneous-move (sequential-move) outcome can be an equilibrium outcome in a private duopoly under significant (insignificant) environmental externality, but this result can be reversed in a mixed duopoly. We also show that when environmental externalities are significant, public leadership yields greater welfare than private leadership, and that public leadership is more robust than private leadership as an equilibrium outcome. Finally, we find that privatization can result in a public leader becoming a private leader, but this worsens welfare.     

Dynamic Games of Environmental Policy in a Global Economy: Taxes versus Quotas

The effects of environmental policy on the global environment as an international public good with a stock externality and national welfare are examined in a model with trade in a polluting commodity. The welfare effects of environmental policy, decomposed into terms of trade, abatement cost, and environmental damage effects, induce governments to adopt a strategic use of their policy measures. In the absence of international cooperation on environmental policy, it is demonstrated that the emission tax game brings about larger strategic distortions than the emission quota game.     

A consumer-based model of competitive diffusion: the multiplicative effects of global and local network externalities

Competitive diffusion of two incompatible technologies, such as PC vs. Macintosh, VHS vs. Betamax and so on, is studied under the framework of a spatial game in which consumers are distributed on a two-dimensional square lattice network. The consumers play coordination-like games with their nearest neighbors and imitate the most successful strategy in their neighborhood in terms of aggregated payoffs after each round. The effects of global network externality are realized in the dynamic payoff matrix of the game, and the framework of spatial game provides the model with the effects of local network externality. These two types of externalities are set as multiplicative, that is, as nonlinear. Both simulations and mean-field approximation show that not only total but also partial standardization (robust polymorphic equilibrium) occurs depending upon the parameters and initial configurations, even when there are positive effects of both global and local network externalities. Moreover, effects of innovation factors that alter paths toward a lock-in situation are studied. It is shown that both the timing and the size of the innovation factors matter for a disadvantaged technology in order to overwhelm a market.JEL Classification: C7, D8, O3We are obliged to Professor John Paul Boyd at the University of California, Irvine and our anonymous referees for their constructive comments.     

Binary Games with State Dependent Stochastic Choice

This paper studies a stochastic equilibrium selection model for binary coordination games. Players switch strategies stochastically so that the mistake probabilities are fully dependent on the population states. A probabilistic behavior is said to be aspiration (imitation, resp.) oriented if strategy switches are mainly driven by the aspiration (imitation, resp.) effect. In general, a strategy switch by one player generates externalities on others. Strategies in a coordination game can be classified according to the relative magnitude of their externality effects. It is shown that the selection outcome for a linear coordination game is determined in a specific way by the balance of the risk dominance, the aspiration/imitation, and the externality effects. It is also shown that an aspiration (imitation, resp.) oriented behavior tends to select payoff dominant (maxmin, resp.) equilibrium and that risk dominant equilibrium is always selected if and only if the aspiration and the imitation effects exactly cancel each other out, which in turn makes the selection process insensitive to externality effects. Journal of Economic Literature Classification Number: C72.     

Optimal taxation of externalities interacting through markets: A theoretical general equilibrium analysis

This study develops a theoretical general equilibrium model to examine optimal externality tax policy in the presence of externalities linked to one another through markets rather than technical production relationships. Analytical results reveal that the second-best externality tax rate may be greater or less than the first-best rate, depending largely on the elasticity of substitution between the two externality-generating products. These results are explored empirically for the case of greenhouse gas and nitrogen emissions associated with biofuels and petroleum.     

Trade,environment, and income inequality: An optimal taxation approach

In a small open economy, how should a government pursuing both environmental and redistributive objectives design domestic taxes when redistribution is costly? And how does trade liberalization affect the economy's levels of pollution and inequalities, when taxes are optimally and endogenously adjusted? Using a general equilibrium model under asymmetric information with two goods, two factors (skilled and unskilled labor), and pollution, this paper characterizes the optimal mixed tax system (nonlinear income tax and linear commodity and production taxes/subsidies) with both production and consumption externalities. While optimal income taxes are not directly affected by environmental externalities, conditions are derived under which under‐ or over‐internalization of social marginal damage is optimal for redistributive considerations. Assuming that redistribution operates in favor of the unskilled workers and that the dirty sector is intensive in unskilled labor, simulations suggest that trade liberalization involves a clear trade‐off between the reduction of inequalities and the control of pollution when the source of externality is only production; this is not necessarily true with a consumption externality. Finally, an increase in the willingness to redistribute income toward the unskilled results paradoxically in less pollution and more income inequalities.     

Consumption externality and indeterminacy under increasing returns to scale and endogenous capital depreciation

This paper incorporates negative consumption externality embodying “jealousy” and “running away from the Joneses” into Guo and Lansing (2007)'s model with production externality and endogenous depreciation, and examines how consumption externality helps to generate equilibrium indeterminacy together with production externality. Specifically, the existence of consumption externality reduces the upper and lower bounds of production externality for local indeterminacy, and when the degree of consumption externality increases, the upper and lower bounds of production externalities for local indeterminacy are both reduced.     

Revenue-Neutral Environmental Tariff Reform, Growth, and Welfare

This paper analyzes the growth and welfare effects of revenue‐neutral tariff reform in a small open endogenous growth model with environmental externalities. As is the case in countries that depend primarily on imported energy, the employment of a foreign intermediate good causes negative environmental externalities in production. This paper shows that substituting a tariff on the foreign intermediate good for a tariff on the foreign consumption good in a revenue‐neutral way raises the growth rate and the welfare, if the environmental externality is sufficiently strong and if the elasticity of substitution between inputs lies within a certain range.     

Liability Insurance and Choice of Cars: A Large Game Approach

If a car, already on the road, is replaced by another one, more expensive to collide with, a negative externality spills over to other drivers. This paper studies such externalities, relating them to insurance and incentives. It formalizes links from liability rules to choice of car. By assumption, insurance is cooperative but car acquisition is noncooperative. Construing drivers' interaction as a large game, the paper considers how a Nash equilibrium—and its efficiency or fairness—is shaped by the underlying liability regime.     

Stability and limit cycles in one-dimensional dynamic optimisations of competitive agents with a market externality

This paper considers low dimensional (more precisely, one state variable) dynamic optimisation problems of competitive agents. These individual decisions lead to a dynamic externality for the evolution of the system. However, the impact of an individual and competitive agent is negligible and thus each agent considers this evolution as exogenous data. This leads, assuming rational expectations (perfect foresight due to the deterministic set up), to motions in the three dimensional space of state, costate and externality. Considering the fact that such externalities are widespread, e.g., R&D in the literature on new growth theory, pollution in environmental economics, etc., the incorporation of such externalities due to competitive markets is important, yet this incorporation may alter the stability of the system. Indeed, complex policies such as stable limit cycles are sustainable in such a low-dimensional economy, even for a separable and strictly concave model.     

Pollution Control in Open Economies: Implications of Within-period Interactions for Dynamic Game Equilibrium

This paper examines a two-country, dynamic game model of pollution control in the presence of economic interactions between countries within a period, as well as the environmental interaction between periods (i.e., a change in the stock of global pollution). These economic interactions emerge because of changes in the terms of trade of polluting goods or the market share of domestic polluting industries. It is shown that if within-period externalities exist, a noncooperative equilibrium may result in a smaller stock of global pollution in the steady state than does international cooperation. Moreover, the properties of equilibrium paths depend on the direction and size of such externalities. In addition, trigger strategy equilibria that achieve the outcome of the collusive solution are examined.     

Joint Production,Externalities, and the Regulation of Production Networks

Real production systems are often vertically integrated in thesense that one production process uses the unwanted joint product of another production process as input.This interrelationship links in a non-obvious way the different negative externalities stemming from theproduction processes. An empirical example is the sulphuric acid industry. Our model of a vertically integratedproduction system shows how internalising one currently existing externality may create another externalitywhich has thus far not been existent. We also discuss how environmental policy could deal with this problemwhen regulating integrated production systems.