Conference Agenda

Agricultural production in developing countries like India and China relies on small farms that trade water for irrigation. Most empirical research on water depletion does not take into account the role of water markets when evaluating impacts of policy. We develop a model in which households farm small parcels of land. The high fixed costs of well drilling prevent each farmer from owning a well. This simple framework endogenously generates markets for groundwater which are commonly observed in many poor economies. The model allows for endogenous entry decisions and provides a flexible framework that can take account of the role of markets when analyzing the effects of policies. We show that if water is abundant, then equilibrium with free entry results in Bertrand competition (or when fixed costs are high, in a mix of monopolistic and Bertrand pricing) with well owners charging higher prices to buyers located closer to them. There is over-capitalization, with too many wells. However, aggregate water use is always lower than it would be if all farms were large enough to afford their own wells. When water becomes scarce, as is often the case in hard-rock aquifers, or if electricity is rationed, we find that there may actually be a socially perverse boom in well-drilling, exacerbating the over-capitalization.