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Working Paper Series

Do Consumers React to the Shape of the Supply?  Water Demand under Heterogeneous Price Structures

Authors

  • Michael W. Hanemann, Goldman School of Public Policy, University of California, Berkeley
  • Sheila M. Olmstead, Yale School of Forestry and Environmental Studies
  • Robert N. Stavins, Harvard University

History

  • Goldman School of Public Policy Working Paper (June 2005)

Abstract

Urban water pricing provides an opportunity to examine whether consumers react to the
shape of supply functions. We carry out an empirical analysis of the influence of price and price
structure on residential water demand, using the most price-diverse, detailed, household-level
water demand data yet available for this purpose. We adapt the Hausman model of labor supply
under progressive income taxation to estimate water demand under non-linear prices. Ours is the
first analysis to address both the simultaneous determination of marginal price and water demand
under block pricing and the possibility of endogenous price structures in the cross section. In
order to examine the possibility that consumers facing block prices are more price-responsive, all
else equal, we test for price elasticity differences across price structures. We find that
households facing block prices are more sensitive to price increases than households facing
uniform marginal prices. Tests for endogenous price structures cannot rule out a behavioral
response to the shape of supply, but suggest that observed differences in price elasticity under
supply curves of varying shapes may result, in part, from underlying heterogeneity among utility
service areas.

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