Friday, July 31, 2009

A Question I Should Have Asked on an Exam

Here's a question I should have asked on an exam, but didn't.

During a prolonged drought, Georgia (the state, not the country) implemented water use restrictions, which limited when people could water their lawns, wash their cars, and use water for other outdoor uses. The eventual result was a reduction in water usage. This reduction in water usage resulted in a decrease in revenue collected by the government-operated water utilities. In order to compensate for this, and to encourage more conservation, the state increased water prices (the rate structure was also changed, but ignore that).

Suppose that after the price increase, the amount of revenue collected by water utilities increases. If price rises, and total revenue collected rises, what can we say about the own-price elasticity of demand for water?

Extra Credit: Why would most economists say that these policy decisions were taken in the reverse order of what should have been done? That is, why would economists say that the price should have been increased first (and perhaps more than once), and only if that failed to reduce usage should other restrictions have been imposed?


2 comments:

MagicWishMonkey said...

Wouldn't that mean the demand is in-elastic, since people would pay more for the same amount of water they normally use, which would increase revenue?

Just a guess, I don't remember much at all from my intro to econ course... engineers don't get much business schoolin' ;)

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