The Australian government has put forward many policies in the past three decades with the aim of increasing water market activity. Water trading is widely thought to transfer water to its highest productive use in order to extract the greatest benefit to society. This paper employs an empirical analysis of the agricultural water market in the Southern Murray-Darling Basin in order to determine whether trading has indeed induced agricultural water use efficiency. This thesis focuses on technical water use efficiency as it searches for evidence that water trade has induced innovation in minimizing water use at the farm level. This research is done on three different scales in order to test the relationship between water trade and the efficiency of its use in several situations. First a cross-sectional analysis of the Goulburn Murray Irrigation District shows an increasing trend in water use efficiency between 1998/99 and 2010/11, although only a weak relationship with trade is found. Second a panel-data regression is performed across the four Murray-Darling Basin states in order to estimate the relationship that both permanent and temporary trade has on water use efficiency. The results of the panel regression conclude that while a 1GL increase in permanent water entitlement trade has led to a 0.00089ML/Ha increase in water use efficiency over the past 15 years, there is no hard evidence that temporary trade has had the same effect. Finally a case study of the dairy industry in the Goulburn region models the incentives faced by farmers who can substitute between feed grain and water for pastured grass as production inputs. Given water and grain prices it is possible to illustrate the optimal decision making of farmers in 2007/08 to see the positive impact of water trading in promoting economic efficiency. This thesis makes an important empirical contribution to the current literature on water markets. The analysis done determines the relative success of permanent water entitlement trade in inducing innovation in water use; this innovation in water use increases technical water use efficiency.