Optimal Water Metering and Pricing

Abstract

Marginal cost pricing of running water and sewerage services haslong been the default recommendation of economists and natural resource specialists to firms and local governments. However, optimal water rate calculation considering the optimal number ofmeters has not been thoroughly treated in the literature. The socially optimal number of meters crucially depends on the price of water charged by the Water Company. This is because whether or not metering is justified in economic terms will depend on the decline in water consumption and therefore in water production costs. This paper combines the optimal pricing and theoptimal metering issues in one optimization problem. Both in a centralized and in a decentralized way, the optimal number of meters is determined simultaneously with the optimal per unit water rate. The Rateable Value System (RV) (i.e. the ‘Status Quo’ or benchmark regime) is confronted with Universal Metering (UM),Optimal Metering (OM) and Decentralized Metering (DM) in terms of optimal water rates and the socially optimal number of meters.Except for RV, the results of (UM), (OM) and (DM) all suggest that price should be set equal to marginal cost and that the optimal number of meters will be determined by a functional form combining water, metering costs and water demand characteristics. Conclusions and policy recommendations are drawn from the theoretical analysis.