Water pricing with permits

Water scarcity is a problem that is likely to become more prevalent in many parts of the world in the near future. Changing water pricing schemes to reduce households’ water demand could be one policy to address the problem. Given households’ price-inelastic water demand, such an approach would likely require substantial price increases to reduce water demand. We propose an alternative pricing scheme that issues water-use rights (permits) to households at prices that cover a water supplier’s costs. These permits can be traded at the end of the year: households with excess permits are redeemed, while households in need of additional permits must purchase them. We show that, in such a setting, households’ opportunity cost considerations can curtail water consumption and yield lower water bills than a policy that increases volumetric rates.