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We employ (1) an optimal control model to gain insights on the problem’s dynamics, and (2) stochastic dynamic programming to determine optimal funding strategies using a specific application. We analyze how a planner should optimally allocate payments, depending on whether the expected externalities are negligible, negative, or positive. Such externalities may be negative if diminishing returns dominate, or positive if mechanisms such as “social diffusion” dominate. Given the expansion of payments for water-based ecosystem services (PWES) worldwide, two relevant issues are as follows: (1) determination of efficient allocations of payments among land managers, and (2) how this might change when paying one manager to implement a best management practice (BMP) to enhance an ecosystem service impacts the cost-effectiveness of BMPs considered by other land managers not currently involved in PWES.
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