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 utility's marginal cost of service is $100/af and that consumers have a demand elasticity of-0.20. Baseline consumption is 1,000 af.
a) Calculate the average and marginal welfare cost of 10% and 20% rationing under the assumption that demand is linear.
b) Repeat these calculations under the assumption that demand is isoelastic.
c) Suppose the utility gives away the first 100 af of water to its customers. How would this affect your answer to a) and b)?