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Marginal Cost Analysis

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There is a growing concern for the operations of water utilities responsible for supplying potable water (Renzetti, 1999). This trend has been encouraged by a variety of factors such as difficulties in maintaining aging capital stock, inability for cost recovery, water pollution and inefficiencies associated in allocating scarce water resources (Renzetti, 1992b). The NWSDB withdraws water to provide for the final use by the utility's residential, commercial, industrial and other customers and for various public functions. The NWSDB extracts raw water from sources such as aquifers, reservoirs, rivers and then treats it in various ways including filtration, chemical treatment to meet the public health standards and taste. This water is then distributed through a network of pipes to consumers. Production is measured in terms of the amount of water delivered to customers and generally this is not the same amount of water extracted from its sources as losses occur in the transmission (NWSDB, 2002).

An important feature of pipe-borne water facilities has been the level of subsidies and grants provided by the government (Renzetti, 1999). Revenues collected by the NWSDB directly from users account for only a portion of utilities total costs. The NWSDB recent annual report estimated that the average contribution of water user charges to operating, maintenance and capital costs was approximately 32 per cent (NWSDB, 2006b). It is interesting that a review of pipe-borne water supply systems in both developed and developing countries found that charges to consumers typically cover only an average of 35 per cent of the total cost of supply (Easter, et al., 1993; Renzetti, 1999). A major task for water utility operators is the determination of the appropriate rate structure for water services. While there are a number of water tariff reforms that are discussed in the literature, most of these focus on marginal-cost pricing (Kim, 1995). The goal of marginal-cost pricing for water is to provide the correct incentive to allocate and conserve water in an economically efficient manner. This efficiency serves to alert society about the cost of producing another unit so that usage can be adjusted accordingly (Hall, 2006).

Document Type: Research Article


Publication date: January 1, 2011

More about this publication?
  • Demand, Supply and Welfare Aspects of Pipe-borne Water in Sri Lanka
    This book identifies under-pricing as the major problem faced by the Sri Lankan pipe-borne water sector. Recently, the water authority in Sri Lanka restructured its pricing strategy for pipe-borne water with the objectives of reducing water consumption and expanding the network. However, the success of the current pricing structure in achieving these objectives is uncertain. Therefore, to overcome the problems, this study examines the use of cost-reflective alternative pricing strategies for pipe-borne water distribution services. The book evaluates current and alternative pricing strategies for water against the criteria of efficiency and equity while maintaining the financial viability of the national water utility.
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