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Abstract There is growing recognition that coastal water quality is interdependent with agricultural management in coastal catchments. Economic-incentive-based instruments can be used to internalize the negative externalities from coastal water pollution. Bio-physical and socio-economic heterogeneity across farms is expected to be an important factor in explaining differing rates of adoption of management practices. This paper hypothesises that: i) different types of farmers are likely to respond differently to incentive payments that promote the adoption of management practices for Great Barrier Reef water quality improvement, and ii) if policy makers account for heterogeneity, cost-effectiveness of incentive payments will increase. Results show that if government paid farmers 100% of the transition costs of moving from their current practices to improved practices, and given current technologies, water quality improvement for the case-study region would be approximately 56% (measured as a reduction of dissolved organic nitrogen at the end of river). Total costs for the region would be almost AU$ 30 M over the planning horizon of one cropping cycle of 6 years. Results furthermore show that as the policy seeks more ambitious land-use changes, from common practice to improved practice to aspirational practice, the public cost of incentive payments increase at an exponential rate. Larger farms make the shift sooner as they are able to offset fixed investments against increased revenues over greater areas. [ABSTRACT FROM AUTHOR]