internalize the open-access problem, correct pricing of electricity for pumping, in a situation where pumping costs are the only costs expended by farmers to withdraw groundwater, would imply an electricity price with two components. The first component reflects the basic electricity provision cost; and the additional component reflects the marginal value of (remaining) standing groundwater. Pricing electricity correctly then requires that both these components be calculated, and charged to users.<sup>2</sup> The first component, true (social) electricity costs of pumping, should in principle be straightforward to measure. The second component, marginal groundwater value, is more complex. The perhaps most extensive treatment of this issue to date is found in National Research Council (1997). This report makes a very useful distinction, between two value components related to standing groundwater, namely 1) extractive value, and 2) “in situ” value. The former is the value of the standing groundwater for the purpose of future use of this water; in our context, this value mainly reflects use of irrigation water for agriculture given the focus on India. This is the value notion we will have in mind with our analysis in the following. The latter represents other services rendered by standing groundwater. “In situ” groundwater services can also include a) the buffer value against future possible shortages; b) less subsidence of the land surface due to ground water withdrawals; c) protection against sea water intrusion; d) protection of general groundwater quality; e) habitat and ecological diversity considerations; and f) providing discharge to support recreational activities. These services may in aggregate be important, but they will not be part of the analysis in this note.

There already exists a long-standing and sizeable literature on the general topic of optimal groundwater value and extraction policy. Early contributions to this literature include Burt (1967), Brown and Deacon (1972), Brown (1974), and Gisser and Mercado (1973), Gisser and Sanchez (1980), Gisser (1983); among more recent contributions we may mention Burness and Martin (1988), Provencher and Burt (1993), and Boyle and Bergstrom (1994). The current presentation builds in part on the analysis from these contributions, but goes further in certain respects, in particular by focusing much more directly on the basis for an intuitive understanding of the basic principles of the problem as they pertain to the Indian situation. We strip away what are unnecessary and complicating elements for our purposes and focus on the relationship between current extraction and future costs.

Work on this topic also exists with specific reference to specific countries. Banerji et al (2006) provide a derivation of the shadow price of groundwater, with an attempt to calibrate the model to the concrete groundwater situation in India. The calibration of their model to the Indian economy indicate a positive, but rather small, mark-up on basic electricity cost, approximately 15 percent. Another recent paper modeling such costs is IFPRI (2010). One purpose of this note is in this context to provide an analytical framework, and ultimately our own independent calibration to the Indian situation, that may be compared to the results obtained in that report, and hopefully useful in its own right.

# **2. Simple model for deriving the true economic value of groundwater**

Consider an agriculturally productive region, with a large number of small farmers, where groundwater is extracted (pumped) to service agricultural needs. We set the amount of groundwater existing in (at the end of) a given period equal to Gt which is at the same time

> 2 The literature also recognizes a third possible inefficiency, what is called a “strategic externality”, not discussed here; see Negri (1989), Provencher and Burt (1993), Rubio and Casino (2003).