A simulation of water markets with transaction costs

Most theorists regard transaction costs as one of the key lenses to understand the water rights market. This paper proposes a theoretical model of water rights trading with transaction costs according to the idea of costs minimization. Applying the model to the Yellow River Basin (YRB), we evaluate the potential of investment savings from introducing the trans-jurisdictional water market to achieve the water-saving targets of agricultural and industrial sectors. The simulation results confirm that the potential benefits from the trans-jurisdictional water markets are considerable in the condition of zero transaction costs, and the benefits are inclined to increase with the decrease of transaction costs. The potential of trading water between the agricultural sector and the industrial sector is much larger than within the agricultural sector. The simulation also implies that the agricultural sector is more sensitive to transaction costs than the industrial sector, and thus priority should be given to reduce the transaction costs paid by the agricultural sector in the institutional design of inter-sectoral water transfers. (C) 2011 Elsevier B.V. All rights reserved.