Water pricing reform, economic welfare and inequality

Abstract

Access to water has become an important policy goal in South Africa. A tariff system including free access for the basic residential water supply, and an increasing block tariff has been introduced all over the country. Water is a necessity, but for most households the marginal consumption is used for less important options. This must be reflected both in the water demand and in the pricing policy. This article introduces three different welfare functions, all including a group of rich consumers and a group of poor ones. The standard additive utility welfare, the weighted utility welfare and the Rawlsian welfare function are all used. For each of them the block tariff system is used to find the maximum welfare. We also discuss how the 'water for free' policy affects welfare, and how to set a low price segment or a free amount of water and the block tariff in each case. For each tariff system we also do comparative statistics of the parameters to study how changes in the policy approach will influence the optimal water tariff system. In conclusion the article explains how the choice of pricing policy can reflect the underlying welfare considerations.