AbstractIn addition to improving the allocative efficiency of water use, water markets may reduce irrigation‐related water quality problems. This potential benefit is examined with a nonlinear programming model developed to simulate agricultural decision‐making in a drainage problem area in California's San Joaquin Valley. Results indicate that a 30% drainage goal is achievable through improvements in irrigation practices and changes in cropping patterns induced by a water market. Although water markets will not generally achieve a least‐cost solution, they may be a practical alternative to economically efficient, but informationally intensive, environmental policies such as Pigouvian taxes.