Capacity Choice of Dams Under Rivalry Use and Externalities

Abstract

This paper studies the relation between optimal dam capacity and water management under rival uses and externalities. We extend the hydropower generation model, based on Haddad (2011), by including in a welfare optimization model: (i) the competing use of water resource, (ii) non-linear building cost of dam capacity and (iii) externalities. We obtain the optimal dam capacity for multi-functional dams. This includes providing infrastructure for industrial and households water use; hydropower generation and irrigation; storing water in the wet season for use in the dry season; and mitigating ‡ooding damages. The optimal solution shows that optimal dam capacity is determined by (1) the marginal bene…ts of hydropower generators, (2) the marginal costs of ‡ooding damage, and (3) the constraining factors. Moreover, the optimal water management can be achieved by using derived seasonal prices in a decentralized manner.