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The impact of current Federal Crop Insurance Program has attracted interests and attention of many economists and policymakers. There have not been any studies that examine the impact of crop insurance on agricultural water use and how different policy designs would affect moral hazard in agricultural water use. Moral hazard could play a role in irrigation decision by incentivizing farmer to choose riskier irrigation management strategy. Without proper design, FCIC program could affect the long-term sustainability of water resources and amplify the magnitude of the current problem such as aquifer depletion and degradation of freshwater ecosystems. We use numerical simulation to solve for optimal water use. We found that there is a potential for moral hazard when the cost of irrigation is high. Hence, some conservation policies that motivate a reduction in water use through increasing irrigation cost may amplify the effect of moral hazard in irrigation. Therefore, we found that there is a need for explicit consideration of the unintended side-effects of crop insurance on farmers' irrigation water use decisions, in particular in regions experiencing water scarcity and rising marginal costs of irrigation.
Advisor: Taro Mieno