Mixture and distribution of different water qualities: an experiment on vertical structure in a complex market

Abstract

We set up a model of water management, which is inspired by the possibility of mixing water of different qualities. Water is supplied to two types of consumers with different preferences for water quality and quantity. A distributional knot may exist which optimally distributes the supplied water in the downstream market. Different scenarios compare experimentally the advantages of a centralized versus a decentralized resource management. We conducted experiments with 14 markets in three different settings, labelled as “upstream monopoly”, “upstream duopoly” and “duopoly-monopsony”. We find that a two-product monopoly performs better than the duopoly regarding social welfare and volatility with respect to prices and production. Especially, the centralization of information enhances learning in the market considered. An interesting observation is that monopolistic subjects post much lower price offers at the outset of the experiment than duopolists do. However, in the course of the experiment production is lower and prices are higher in the monopolistic structure. In the duopoly-monopsony case, monopsonistic subjects failed to exercise market power and market prices did not reflect correctly the differences in qualities. Nevertheless, increased upstream competition and downstream market power helped to mitigate the waste of resources in the economy.