The implementation of recently proposed Sustainable Diversion Limits would reduce the maximum long-term annual average quantity of water that can be taken from the Murray-Darling Basin. Satisfying environmental objectives by reducing the volume of water extracted from the Basin has an opportunity cost in terms of foregone irrigated agricultural production. This thesis will use a version of the state-contingent model of the Murray-Darling Basin developed by Adamson, Mallawaarachchi, and Quiggin (Adamson et al., 2007) to simulate the effects of reducing the amount of water that can be extracted by irrigators. The model calculates the optimal mix of irrigated production activities subject to water constraints under two water flow solution concepts; one corresponding to sequential utilisation of the Basin's water resources by each catchment as it flows through the Basin, and another which maximises the returns to agricultural production in the Basin as a whole by allowing water to be traded between all catchments.
The Australian Government has been purchasing water entitlements from willing sellers since 2007-08 to return water to the environment and smooth the transition that it is anticipated will follow the implementation of Sustainable Diversion Limits. The state-contingent model has been configured to simulate a water buyback. This is a novel use of the model. The water buyback model is able to simulate the effect of the Australian Government offering to purchase water entitlements. The water buyback model includes differentially priced water sale options with different levels of security, as is found in actual water markets. The model demonstrates that the choice of prices offered in a water buyback is crucial in satisfying the multiple goals of minimising the impact on agricultural production, satisfying environmental objectives, and minimising the money spent purchasing water entitlements.