Strategic investment behavior and externalities when accessing groundwater resources: Evidence from the lab

Liu, Zhuo
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University of Delaware
Entry behavior in accessing a common-pool resource is critical to efficient use of that resource, especially when natural characteristics of the resource and economic constraint complicate user’s behavior. Unlike previous work on groundwater resources, this study uses laboratory experiments to investigate firms’ entry investment behaviors. In a twostage game, participants choose between two production possibilities in the first stage (the entry decision) and then decide in the second stage how much of the resource to extract if they enter. The study supports the importance of the resource’s spatial externalities in influencing firms’ entry behaviors. The study also finds out the significance of spatial externalities in affecting both the total social efficiency and entry efficiency. The greatest efficiency loss was found in decisions to enter a mixed privatepublic aquifer. In addition, entry efficiencies were 6.55% lower when participants had an option to exit. Participants in the laboratory demonstrated strategic behavior when accessing and extracting water from the resource with a high degree of interaction between entry and extraction. These results suggest that groundwater management policies should focus on entry and consider interplay of entry with both hydrogeological characteristics of the resource and the options to exit, along with the extraction behavior. Policies designed to increase efficiency should take those characteristics and economic conditions into account and differentiate incumbent and potential entrants. One example is to use differentiated taxes based on spatial natures of the CPR, economic conditions and the players.