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Abstract
We investigate the economic relation between two common approaches to tackling
water scarcity and adapting to climate change, namely expanding water-storage
capacities and improving water-use efficiency. We build, analyze, and extend a simple
model for capacity choices of dams, incorporating stochastically dynamic control of
water inventories and efficiency in water use. We show that expanding water-storage
capacities could encourage water users to improve water-use efficiency and
improving water-use efficiency could increase optimal dam sizes even if water-use
efficiency improvement decreases the water demand. The possibility of
complementarity is numerically illustrated by an empirical example of the California
State Water Project. Our analysis implies that, if complementarity holds, resources
should be distributed in a balanced way between water-storage expansions and
water-use efficiency improvement instead of being concentrated on one side with the
other side being ignored.