Pricing with changing welfare criterion : an application of Ramsey-Wilson model to urban water supply

Abstract

Tariff rates based on Ramsey - Wilson model of changing welfare criterion satisfying equity and efficiency have been estimated for three categories of consumers of an urban water supply in India. The design necessitates values of marginal cost and price elasticity. Paucity of data severely restricts estimation of marginal cost compelling to use breakeven as proxy. Price elasticity is obtained from household expenditure data by applying recoverability theory suggested by Pollak and Wales. The effect of household composition on elasticity has been eliminated by expressing variables on a per capita basis using adult equivalent scale (AES). Calculation of AES for water is based on Prais-Houthakker incremental method. The scale indicates that it is totally different from Amsterdam scale, the AES of food. Maximum welfare is given to small quantity consumers by charging a rate below breakeven combined with a subsidy arising from the surplus generated in the markup of large quantity consumers. The middle group is charged only the breakeven rate. The model can be generalised to any number of groups by assigning different welfare weights ranging from zero to one. The model breaks down if the rate exceeds stand-alone cost. JEL Classification : H41, D4, Q25 Key words: tariff rates, second best prices, adult equivalent scale, welfare weights, stand alone cost