Pricing for Scarcity

In many areas where water is not abundant, water pricing schedules contain significant nonlinearities. Existing pricing literature establishes that efficient schedules will depend on demand and supply characteristics. However, most empirical studies show that actual pricing schemes have little to do with theoretical efficiency results. In particular, there are very few models recommending increasing blocks, whereas we present evidence that this type of tariff structure is abundantly used. Water managers often defend increasing blocks, both as a means to benefit smaller users and as a way to signal scarcity. Naturally, in the presence of water scarcity the true cost of water increases due to the emergence of a scarcity cost. In this paper, we incorporate the scarcity cost associated with insufficient water availability into the optimal tariff design in several different models. We show that when both demand and costs respond to climate factors, increasing marginal prices may come about as a combined result of scarcity and customer heterogeneity under specific conditions. We also investigate the effect that rising water scarcity in the long run can have on the steady-state amount of capital invested in water storage and supply infrastructures and obtain some results that are consistent with the static models.