The optimal allocation of water along a system of rivers: a continuous model with sequential bidding*

Abstract

This paper uses a control theory approach to analyse the collectively optimal rate of extraction along a river system and constructs a bidding mechanism that would produce the required prices at each point. It also analyses some characteristics of this mechanism. This approach brings some new perspective to existing work on externalities. It also helps bring to light some aspects of the system as a whole that may be less obvious in a more piecemeal analysis, including the fact that there may not be an optimal solution to the allocation problem. Although the bidding mechanism may be difficult to implement, it may be possible to design various forms of hybrid schemes that have practical value.