This paper presents an operational approach to setting prices for groundwater in accordance with the interannual variability of monsoon rainfall and the dynamic cost of groundwater use to society. The pricing system is designed for the state of Tamil Nadu, India, where groundwater is largely unregulated and the electricity for pumping is heavily subsidized. Depletion of aquifers during the primary growing season causes environmental damage and drying of wells. The proposed price-setting system estimates the marginal social cost of groundwater use based on the current state of aquifer storage and the forecast of the coming monsoon. Prices are set prior to onset of the monsoon so farmers can plan crop rotations according to the expectation of seasonal rainfall as reflected in the pricing signal. During years that forecasts accurately characterize the probability distribution of monsoon outcomes the market signal encourages economically efficient use of the resource. When monsoons differ from the expected outcome farmers are cushioned by ancillary effects of the pricing system. (c) 2006 Published by Elsevier Ltd.
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