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Price Reforms and Welfare Effects

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One of the most important tasks of regulatory authorities is to determine an appropriate pricing scheme for the services provided by the water utility. Water utilities are often criticized for inefficient pricing practices (Renzetti, 1992b, 1999). Yet, there is limited evidence regarding the extent and effect of divergences between prices and marginal cost of supply. It is important to analyse the economic gains or losses under different tariff structures such as marginal-cost pricing, average-cost pricing, two-part tariff and two-block tariffs.

The purpose of this chapter is to evaluate the potential for welfare gains obtained as a result of the NWSDB moving from the current pricing practices towards more efficient prices. This chapter brings together the NWSDB's costs of supply estimated in chapter 6 and the structure of residential, industrial and commercial water demands estimated in chapters 4 and 5. These estimated cost and demand coefficients are employed in a simulation program to compute the change in welfare achieved by replacing the NWDSB's current price structure with alternative prices. Moreover, estimated cost and demand equations are combined with the NWSDB prices to determine the extent to which current consumption levels deviate from those predicted under alternative pricing. The alternative pricing arrangements considered here include SRMC and LRMC pricing, average-cost pricing and two-block pricing. This chapter therefore, provides an addition to the very few studies estimating welfare changes of reforming water prices in developing countries and is the first study for Sri Lanka.

An extensive literature exists on welfare measurements. The Marshallian Consumer Surplus (CS) is the measure of choice in most studies, since it is measurable using data typically available (S. Brown & Sibley, 1986). Compensating Variation (CV) and Equivalent Variation (EV) are being increasingly used for welfare estimations. Deadweight loss, defined as the excess of benefits that society as a whole loses by failure to adopt a policy in question, is also a tool used in welfare analysis.

Document Type: Research Article


Publication date: January 1, 2011

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