CUDARE Working Papers

This paper investigates the economic relation between water storage capacities and the alternative adaptation or mitigation approaches to improving the water resource sustainability. We establish and analyze a new stylized model for the determination of optimal dam capacities, which incorporates stochastic inflows, optimal water inventory management, and conservation efficiency. We prove the following three results: 1) We first show that if improvement in water allocation efficiency shifts the marginal water release benefit (or the water release demand) proportionally up, then the dam designer should optimally choose larger but not smaller dam capacities. 2) By assuming an isoelastic water release demand, we then show that dam capacities and conservation technologies won’t be substitutes, but complementary to each other, in the sense that larger dam capacities will increase water users’ incentive to adopt conservation technologies, and that the adoption will also induce larger optimal dam capacities, if and only if the water release demand elasticity is larger than one. 3) Alternatively, by assuming a linear water release demand, we show that dam capacities and conservation technologies will always be complementary to each other, as long as the adoption doesn’t reduce overflows much. Comparing with Result 2 suggests that the specification of the water release demand is crucial in determining the relation between dam capacities and conservation technologies. All of the results imply that to improve the water resource sustainability, there could be shared ground between the apparently competing policies encouraging respectively water storage capacity expansions and the alternative adaptation or mitigation approaches. ∗We thank Kendon Bell, Judson Boomhower, Larry Karp, Zhimin Li, Mechel Paggi, Jeffrey Peterson, Renato Seixas, Andrew Stevens, Rebecca Taylor, Christian Traeger, Daniel Tregeagle, Russell Tronstad, Brian Wright, and the participants in the ERE Seminar at UC Berkeley, the 2014 WAEA Annual Meeting at Colorado Springs, and the 2014 GARESC Conference at UC Davis for their valuable comments. An earlier version of this paper wins the Second Place in the Graduate Student Paper Competition at the 2014 WAEA Annual Meeting. †Corresponding author. Affiliation: Department of Agricultural and Resource Economics, University of California at Berkeley. Address: 207 Giannini Hall, University of California, Berkeley, CA 94720-3310, U.S. Email: phd.yang.xie@gmail.com. ‡Affiliation: Department of Agricultural and Resource Economics, University of California at Berkeley.