Suppose that a water utility has a simple volumetric pricing structure and charges $800/af for water service; a price that just covers its average cost. Suppose that the utilityâs marginal cost of service is $100/af and that consumers have a demand elasticity of -0.2. Baseline consumption is 1,000 af.
(a) Calculate the average and marginal welfare costs of 10% and 20% rationing under the assumption that demand is linear.
(b) Repeat these calculations under the assumption that demand is isoelastic. (Hint: there is a very useful equation in one of your readings that will help with this problem.)