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.

Municipal water utilities choose rates to recover costs, encourage conservation, and reduce burdens on low-income customers, which may deviate from optimal two-part tariffs. Theory suggests that prices should equal marginal cost with fixed costs recovered via fixed fees or alternative tax revenues. Using rate structure and municipal finance data for more than 700 utilities, I show that prices are discounted severely for low levels of consumption within nonlinear rate structures, leading to suboptimal usage and budget deficits, particularly in poorer and smaller communities. Marginal-cost pricing corrects allocative inefficiencies, and equity and cost-recovery goals can be achieved through more progressive approaches to fixed costs, which are both highly regressive and a large share of total costs.

Economists often advocate for pricing mechanisms based on marginal prices to promote efficient water usage. However, consumers may find it difficult to interpret complex water pricing structures, such as nonlinear two-part tariffs that serve multiple policy objectives. In this study, we examine consumer behavior following the introduction of volumetric pricing in Sacramento, California. Our analysis reveals that volumetric pricing reduces average water consumption by 5%, although there is considerable variation among consumer groups. Low-consumption households, whose bills decreased under the new pricing structure, increased their water usage by 4% despite facing increases in marginal price. These results suggest that consumers are more responsive to changes in their total bills than to marginal prices. We interpret this finding as evidence that consumers respond to changes in total bill amounts when making consumption decisions, which has important implications for designing rate structures in systems using two-part tariffs.

This study provides new empirical insights on the distributional effects of an extreme weather event on household wealth. Our focus is on an extremely severe winter that hit Mongolia in 2009/10 and caused the death of more than 10 million livestock. The analysis builds on three waves of household panel survey data collected in the post-shock period. The identification exploits the quasi-experimental nature of the extreme event. Our analysis unravels the heterogeneity in effects across wealth groups, distinguishing between exposure, susceptibility, and coping. Results show that wealth inequality among pastoralist households increased sharply after the extreme event. Exposure to extreme weather conditions has a significant, negative, and large effect on both asset losses and post-shock wealth, while controlling for household, district, and province characteristics. The effect vanishes over time, but is still significant up to four years after the event. Pre-shock wealth does not influence losses, holding other factors constant, but households with more assets at risk experienced higher losses. Coping strategies only cushion the negative shock effects for the wealthiest households. An understanding of the distributional effects caused by extreme weather events is important for policy implementation to reduce within-country inequality.