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Show Price P2 P3 Price fi N, ^\^ x^\. z Y^""\ D 1 Q0 Ouant it v 0 Qj Q2 Q3 Qc Quantity Figure 6. Second best marginal cost pricing in a Figure 7. Average cost price discrimination in a decreasing cost industry. decreasing cost industry. rectangle XBQ0Q1. The remaining quantity can be sold for a price P3 ( the efficient price) and the revenue collected is equal to the rectangle YCQ3Q2. Notice that in each case the price follows the marginal cost curve and that the total quantity consumed is equal to the efficient level of resource use. Prices and block sizes can be set so that the sum of the revenue rectangles, PjAQiO+ XBt^ Q+ YCC^*^. equals the costs represented r> y rectangle PaGQ30 which would cover all costs. This system charges the most for the initial quantity consumed, but reduces the cost for additional consumption. Large users are given preferential treatment in that they pay a lower marginal cost, but it is also larger users who create the economies of scale which enable the water utility to sell water at this price. If the utility follows decreasing block prices based on average costs, the revenues far exceed the costs. If the price increments are set equal along the average cost ( AC) curve ( Figure 7), the total cost is equal to the rectangle P3CQ3O. The revenue is equal to the sum of rectangles P1AQ10+ XBQ2Qi+ YCQ3Q2 and exceeds by the sum of rectangles P1AZP3+ XBYZ. Not only are revenues substantially aoove costs, but resources are under utilized by quantity Q^ QQ- The efficient price and quantity would be Pe and Qc respectively. If the available supply is limited, this is a good way to reduce use while at the same time generating sufficient revenues to pay for system expansion. Decreasing block rates have built in conservation incentives because water is metered and priced according to use. This assigns a positive cost to water use, and the marginal cost is equal to the price of each consecutive block. Economic efficiency is also enhanced by the metered water rate scheme. Substantial revenue potential exists without making the system significantly more complex to administer. Under the consensus criteria of equal treatment of equals, the declining block rate scores well. It is based on relevant circumstances, including volume of water use. It is impersonal yet precise, and a user can calculate his bill or charge in advance. A bill may fluctuate in successive periods; but a user can be certain that it will always be based on the same circumstances. A declining block rate is progressive in that as use increases, the charge also increases. However, it does not increase proportionately. Those who use more pay more, but have a lower average cost than those who use less. For a declining block rate to be progressive, water use must increase faster than income. Benefits increase with increased use but in a declining marginal benefit way, which indicates that benefits are progressive with income or wealth, providing water use and income are positively correlated. The declining block rate does not distribute the benefits and burdens equally among households of like income or wealth or take account of the type of income, size and composition of family, or use of income. When a fee is based on volume of use, only by accident are these criteria satisfied. However, because families of like income or wealth tend to locate in close proximity and have similar water use patterns, this type of fee may score better with respect to at least some of the income redistribution criteria. Poorer social groups may be disadvantaged by a decreasing block rate. Large volume users tend to locate toward the periphery of a city and small volume users, including the poor, tend to locate toward the 20 |
