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Groundwater Extraction in the South Korea's Jeju Island sustainability Article Groundwater Extraction in the South Korea’s Jeju Island: A Real Options Game Approach under Price Uncertainty Jaehyung Lee 1 and Heesun Jang 2,* 1 ESG Innovation Center, SK Telecom, Seoul-si 04539, Korea; [email protected] 2 Department of Economics, Jeonbuk National University, Jeonju-si 54896, Korea * Correspondence: [email protected]; Tel.: +82-63-270-3010 Abstract: This paper uses a standard non-cooperative sequential game with two homogeneous players to analyze investment options of groundwater development project in South Korea’s Jeju island. The model is constructed as an option game taking the uncertainty of water price and the irreversibility of investment into account. The results show that the threshold water price of follower increases with the investment scale of both the leader and the follower while the threshold water price for the leader decreases as the investment scale of the leader increases. This makes the leader choose strategies to maximize the amount of groundwater extraction regardless of the follower’s strategy. Based on the results, it is recommended for policymakers to manage sustainable use of groundwater based on the policy measures such as the groundwater extraction quota system. Keywords: real option game; groundwater extraction; uncertainty; irreversibility; Jeju island Citation: Lee, J.; Jang, H. 1. Introduction Groundwater Extraction in the South Jeju is a volcanic island located in the southwest of South Korea. The island is isolated Korea’s Jeju Island: A Real Options from the Korean peninsula, but is about a one-hour distance by flight from Seoul (see Game Approach under Price Figure1). Designated as a special autonomy province that maintains unique history and Uncertainty. Sustainability 2021, 13, culture distinctive from those of the inland of South Korea (hereafter referred to as Korea), 3431. https://doi.org/10.3390/ Jeju island attracts many tourists worldwide. With the attraction of volcanic mountain su13063431 views, clement weather, and beaches, the number of visitors, in particular, from China and Academic Editor: Manuela Lasagna Japan is growing. The average number of visitors to Jeju is estimated to be approximately 13.6 million annually. Received: 15 February 2021 The island with subtropical weather normally records abundant annual rainfall that is Accepted: 17 March 2021 about 1.5 times larger than that on the inland. However, because of the lack of perennial Published: 19 March 2021 rivers, the island is vulnerable to water shortage problems. The water resource on the island is mainly collected mostly beneath the ground due to its unique geological property Publisher’s Note: MDPI stays neutral with permeable basalts into which rain and stream waters easily percolate to accumulate with regard to jurisdictional claims in and move slowly in accessible and exploitable aquifers. This results in a lack of perennial published maps and institutional affil- streams [1]. As there are limited perennial rivers and streams, groundwater is nearly the iations. sole source of water supply. While Jeju, isolated from the inland, has to meet the water demand by itself, the demand for water is expected to increase due to the increasing population and tourists. There are vast amounts of literature discussing the economics of water resources for Copyright: © 2021 by the authors. agriculture, livestock, and other uses [2–11]. Since Rubio and Castro [4] and Fisher and Licensee MDPI, Basel, Switzerland. Rubio [5] introduced the real options approach to water resources, there has been an ongo- This article is an open access article ing expansion of the application including economic evaluation of irrigation [11–13], water distributed under the terms and infrastructure investment projects (e.g., dams and hydroelectric power generation [14–19]), conditions of the Creative Commons and water supply projects [20–25]. Most of the previous studies focus on the economical Attribution (CC BY) license (https:// evaluation of infrastructure investment and water supply project under the assumption of creativecommons.org/licenses/by/ a single player, e.g., supplier, investor, or government. 4.0/). Sustainability 2021, 13, 3431. https://doi.org/10.3390/su13063431 https://www.mdpi.com/journal/sustainability Sustainability 2021, 13, 3431 2 of 11 Sustainability 2021, 13, x FOR PEER REVIEW 2 of 12 However,However, competition among among the the agents agents is isinevitable inevitable given given that that water water resources resources is islimited limited at least at least for a for given a given period period of time. of time.For example, For example, de Sivla de and Sivla Hussein and [26] Hussein focused [26 ] focusedon the water on the competition water competition in South inAmerica South Americaover the La over Plata the River La Plata Basin River and BasinGuarani and GuaraniAquifer System, Aquifer and System, examined and examined the conflicts the and conflicts resolutions and resolutions from a water from politics a water perspec- politics perspective.tive. Cascão Casc[27] ãdefinedo [27] defined the competition the competition for water for resources water resources in the inNile the River Nile RiverBasin Basinas a ashegemonic a hegemonic competition competition caused caused by asymmetric by asymmetric power, power, and andproposed proposed non-hegemonic non-hegemonic ri- ripariansparians for for sustainable sustainable and and equitable equitable use use of of water. water. Lankford Lankford and and Watson Watson [28] [28 ]developed developed thethe riverriver basicbasic game between Tanzania Tanzania and and Nige Nigeriaria to to resolve resolve the the conflicts conflicts on on water water uses uses inin Africa.Africa. AlthoughAlthough a large body of the literature wa wass devoted devoted to to analyzing analyzing water water resources, resources, onlyonly a few few studies studies were were built built on on a real a real opti optionsons game game approach. approach. Laukkanen Laukkanen et al. et[29] al. [29] developeddeveloped a real options game model to to anal analyzeyze the the optimal optimal extraction extraction of of groundwater groundwater amongamong heterogeneousheterogeneous farmers while taking taking the the uncertainty uncertainty of of rainfall rainfall into into account. account. The The heterogeneousheterogeneous farmersfarmers differdiffer in in terms terms of of their their choice choice of of irrigation irrigation technology, technology, which which results re- insults different in different farmer-specific farmer-specific impacts impacts on the on aquifer the aquifer recharge recharge rate. Bhadurirate. Bhaduri et al. [et30 al.–32 [30–] use a32] stochastic use a stochastic Stackelberg Stackelberg differential differential game togame examine to examine sustainable sustainable transboundary transboundary water sharing,water sharing, the case the of case water of distributionwater distribution in the Voltain the Basin Volta of Basin West of Africa Westbetween Africa between Burkina FasoBurkina and Faso Ghana. and Ghana. InIn thisthis paper,paper, wewe buildbuild on the real optionsoptions game model model to to examine examine the the investor’s investor’s optimaloptimal strategy on groundwater development development project, project, which which could could provide provide implications implications forfor policymakerspolicymakers to to manage manage sustainable sustainable use use of of groundwater. groundwater. Specifically, Specifically, we we develop develop a astandard standard non-cooperative non-cooperative sequential sequential game game with with two twohomogeneous homogeneous players players [33] in [33 the] incon- the contexttext of the of thegroundwater groundwater development development project project in Jeju in Island. Jeju Island. The model Themodel is presented is presented as an asoption an option game gameto invest to invest in water in waterdevelopment development project, project, which takes which the takes uncertainty the uncertainty of water of waterprice and price the and irreversibility the irreversibility of investment of investment into account. into account. By combining By combining irreversible irreversible invest- investmentment under under uncertainty uncertainty with non-cooperative with non-cooperative sequential sequential game, game, this paper this paper integrates integrates the thetwo two bodies bodies of the of literature, the literature, i.e., real i.e., options real options and game and gametheory. theory. Real options Real options models models have havebeen used been to used explain to explain uncertainty uncertainty and irreversib and irreversibilityility of investment of investment in a number in aof number contexts, of contexts,but often buttimes often in timesmonopolistic in monopolistic or perfectly or perfectly competitive competitive framework. framework. On the other On the hand, other hand,games games of entry of and entry exit and have exit been have studie beend studied mostly mostlyin a deterministic in a deterministic framework. framework. TheThe rest of the the paper paper is is organized organized as as follows. follows. We We present present the thetheoretical theoretical model model in inSection Section 2. 2Section. Section 3 provides3 provides the numerical the numerical analysis analysis in the incase the of case the Jeju of the Island Jeju ground- Island groundwaterwater development development project. project.Section Section4 concludes4 concludes the paper. the paper. FigureFigure 1.1.
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