A Supply System for Municipal Water with Uncertainties

Abstract

In this chapter, the system of the provision of municipal water through the market mechanism including some forms of “privatizations” is considered in the view of the normative aspects of resource allocation and welfare under the uncertainty of water quality. First, the first and second fundamental theorems of welfare economics are reviewed and the cases that the market mechanism fails to satisfy the optimal allocation are shown. Second, among those cases, the problems relevant to the municipal water supply under the presence of environmental risk and asymmetric information between water supplier and regional consumer are considered. We review the analytical framework of credence goods and show the advantages of using it when the uncertainty of the water quality is at issue. Third, we assume that some private firms have chance to contract to provide municipal water and examine how the credence of municipal water, that means quality regulation, effects on the price and water quality level using an analytical model. A regulator of municipal water provision should control municipal water supplier by means of some kind of penalties and inspections, which work on the risk attitudes of the supplier and the probabilities of detection under informational asymmetry.