Over the last 25 years, economic water policy models have evolved in concept, theoretical and technical methods, scope and application to address a host of water demand, supply, and management policy questions. There have been a number of theoretical and empirical advances over this period, particularly related to estimation of nonmarket, public good water‐related values involving different methods of valuation. We discuss modeling advances including modeling multiple, competing demands, types of incentives and technologies and behavioral responses, incorporation of groundwater and other supply alternatives, integration of institutional factors, and increasing attention to system‐wide impacts. The largest changes in hydroeconomic policy models have been the integration of the individual demand and supply components, inclusion of environmental values, incorporation of governance and institutional conditions (laws, regulations and policies), and expansion to river basin and even interposing scales of analysis. Important areas of future hydroeconomic model advances will be the use of genetic and neurological based algorithms for solving dynamic, stochastic problems, reconstruction of hydrological and economic relationships for remotely sensed data, and the expansion of models to understand and address transboundary water resource economic, hydrologic, environmental and institutional policy, and interdependencies.

[1] In the Rio Grande Basin, water is overallocated, demands are growing, and river flows and uses are vulnerable to drought and climate change. Currently, the basin is in the third year of severe drought; irrigation and municipal water diversions have been severely curtailed; extensive diversions threaten endangered species, and reservoir volumes are nearly depleted. A central challenge is development of policies that efficiently and equitably allocate the basin's water resources among competing uses across political and institutional jurisdictions. A basin-wide, nonlinear programming model optimizes resource allocations and water use levels for the upper part of the Rio Grande Basin to test whether institutional adjustments can reduce damages caused by drought. Compared to existing institutions, we find that future drought damages could be reduced by 20 and 33% per year through intracompact and interstate water markets, respectively, that would allow water transfers across water management jurisdictions. Results reveal economic tradeoffs among water uses, regions, and drought control strategies.

In the Rio Grande Basin of North America, water is overappropriated and demand for water grows while supplies are constrained by drought and climate change. The Basin is currently in its seventh year of drought, and reservoirs are at historically low levels. Thus agricultural and municipal river diversions have been sharply curtailed, and low flows threaten endangered species. A central policy challenge is the design and implementation of plans that efficiently and fairly allocate the Basin's water supplies. Such plans are complicated by the demands of existing water users, potential new users, three state governments, and two sovereign nations. To address these issues, an integrated basinwide nonlinear programming model was designed and constructed for the purpose of optimizing water allocations and use levels for the Basin. The model tests whether institutional adjustments can limit damages caused by drought and identifies changes in water uses and allocations that result from those adjustments. Compared to existing rules governing the river system's water use, future drought damages could be reduced by one-fifth to one-third per year from intrastate and interstate water markets, respectively, that permit water transfers across jurisdictions. Results show hydrologic and economic trade-offs among water uses, regions, and drought control programs.

A severe sustained drought in the Colorado River Basin would cause economic damages throughout the Basin. An integrated hydrologic-economic-institutional model introduced here shows that consumptive water users in headwaters states are particularly vulnerable to veiy large shortfalls and hence large damages because their rights are effectively junior to downstream users. Chronic shortfalls to consumptive users relying on diversions in excess of rights under the Colorado River Compact are also possible. Nonconsumptive water uses (for hydropower and recreation) are severely affected during the worst drought years as instream flows are reduced and reservoirs are depleted. Damages to these uses exceeds those to consumptive uses, with the value of lost hydropower production the single largest economic impact of a severe sustained drought. Modeling of alternative policy responses to drought suggests three general policy approaches with particular promise for reducing damages. Consumptive use damages can be reduced by over 90 percent through reallocation from low to high valued uses and through reservoir storage strategies which minimize evaporation losses. Reservoir management to preserve minimum power pooi levels for hydropower production (and to maintain reservoir recreation) may reduce damages to these nonconsumptive uses by over 30 percent, but it may increase consumptive use shortfalls. (KEY TERMS: economic impacts; drought; water policy; reservoir management; institutions; modeling.) ing interstate consumptive use markets are investigated.An integrated hydrologic-economic-institutional model (CRIM, the Colorado River Institutional Model) for estimating the economic and hydrologic impacts of drought is first introduced. Second, model results are used to develop a detailed assessment of economic impacts of the severe sustained drought under the existing operating rules and policy (the Law of the River). The economic and hydrologic impacts reported are derived directly from the use of CRIM to model the severe sustained drought under this existing River management. Eight alternative policy responses to drought are then modeled. Drought impacts under each policy are critically examined, and several recommendations are provided.