The value of scarce water: Measuring the inefficiency of municipal regulations

0094-1190/$ see front matter 2011 Elsevier Inc. A doi:10.1016/j.jue.2011.11.003 ⇑ Corresponding author. Fax: +1 202 939 3460. E-mail addresses: [email protected] (E. (S.M. Olmstead). Rather than allowing urban water prices to reflect scarcity rents during periods of drought-induced excess demand, policy makers have mandated command-and-control approaches, primarily rationing the use of water outdoors. While such policies are ubiquitous and likely inefficient, economists have not had access to sufficient data to estimate their economic impact. Using unique panel data on residential end-uses of water in 11 North American cities, we examine the welfare implications of urban water rationing in response to drought. Using estimates of expected marginal prices that vary both across and within markets, we estimate price elasticities specific to indoor and outdoor water use. Our results suggest that current policies do target water uses that households, themselves, are most willing to forgo. Nevertheless, we find that rationing outdoor water in cities has costly welfare implications, primarily due to household heterogeneity in willingness-to-pay for scarce water. We find that replacing rationing policies with a market-clearing ‘‘drought price’’ would result in welfare gains of more than 29% of what households in the sample spend each year on water. 2011 Elsevier Inc. All rights reserved.