Multistage Marginal Cost Model of Investment‐Pricing Decisions: Application to Urban Water Supply Treatment Facilities

Abstract

An attempt is made to apply a previously developed general model of investment‐pricing decisions to the particular problem of choosing the timing and sizes of additions to capacity in urban water supply systems. On the basis of empirical data, typical but hypothetical cost and demand curves for water supply are defined and incorporated into the model. The model is then solved under varying assumptions with regard to rate of growth in demand, the level of the discount rate, and the length of the planning horizon. The results are compared in terms of their efficiency with results that could be expected from conventional approaches to the problem by employing certain arbitrarily assumed schemes of average cost pricing combined with rules of thumb criteria for choosing the size and timing of capacity investment. The major conclusions reached are that at present we do not have the empirical data necessary to effectively implement the general model in the water supply area and that the results do suggest that the multistage marginal cost approach toward planning and operating urban water supply systems might be 10–20% more efficient than traditional average cost approaches.

Water Pricing Models: a survey

“…Dynamic programming techniques are employed to derive the optimal capacity expansions and their adequate timing. (Riordan, 1971b) applies the model to urban water supply treatment facilities.…”

Volumetric water pricing, social surplus and supply augmentation

“…1 Volumetric water pricing that fails to consider the effects of current prices on future quantity demanded and the decision of when to augment supply can also generate long-term welfare losses if it results in premature supply augmentation. By contrast, with dynamically efficient pricing it is possible to postpone investment in supply augmentation [25,11,26,8] to the benefit of water consumers.…”

“…The existing literature has long recognized the importance of pricing water to account for the costs of supply augmentation and that postponing investments in new capacity can be cost effective [24,25,11]. In particular, Dandy et al [7] calculated the optimal time to augment water supply capacity in a hypothetical-deterministic setting with endogenously derived volumetric water prices while Timmins [30] showed that if the volumetric price is set at level below marginal cost of supply, as practiced in some western US water utilities, there is a loss of social surplus from the too rapid extraction of water from aquifers.…”

Economics of Water Resources: From Regulation to Privatization

“…Several studies have addressed the potential for most water-supply authorities to exercise joint supply-demand management through integrated pricing and capacityexpansion programs (Gysi & Loucks 1971, Hirschleifer et al 1960, Riordan 1971aand 1971b. A general programming model developed by Dandy et al (1984) is aimed at identifying optimum water-pricing and capacity-expansion policies for water supply in the presence of administrative constraints on price.…”