Economic parameters of water demand management for domestic

Economic parameters of water demand management for domestic use in urban China[I]

Hu Lianqi
North China Municipal Engineering Design and Research Institute

ABSTRACT

Following a summary of the water demand management in urban China relating to domestic water consumption, details are given of the price and income elasticity of demand for efficient urban water resource use, together with a generalized demand equation of domestic use and demand curves. The water demand situation for domestic use is described, and comment is made on the demand and water consumption position as a whole, including an example of marginal cost analysis utilizing a spreadsheet.

The paper examines the parameters relating to urban water management in China such as water demand, water supply, marginal benefit, marginal cost, economic efficiency, price elasticity, income elasticity and affordability, and a demand for domestic projection is made on the base of analysis for the year 2007.
Key words: water demand management; urban China; price and income elasticity; marginal benefit; marginal cost; demand formula.

1. INTRODUCTION
Over the past 20 years, with the implementation of reforming policies to open to the outside world, the living standards of urban residents in China rose rapidly and the quality of life has been greatly improved. Demand for water increased rapidly. Water consumption per capita for urban residents has risen from less then 80 litersper day in 1980 to 135 liters per day in 1997. Total water supply has risen to 47.6 billion cubic meters per year in urban China by the end of 1997 and the trend of water demand increase has slowed in recent years.

Many people picture China as a country which has plentiful water resource reserves ranking sixth in the world. Per capita water reserves, however, are only one fourth of average world levels because of large urban population in China. On the other hand, water reserves are distributed unevenly in space and timing, and are not coordinated with social economic development and population. In the long term, the focus has been on the capital investment in infrastructure to increase the capacity of water supply but water demand management has not been given the appropriate attention. Low water prices that do not reflect the value of water as a scarce resource encourage over consumption leading to an excessive demand for water. If demand is not managed effectively, the cost of meeting the demand will become unsustainable. It is therefore necessary to pursue a strategy for long term price and demand management of water.

The paper describes the domestic demand curves which are useful for price and demand management for water based on analysis of the current water supply in urban China, and a demand equation for domestic water demand was given. Some economic parameters associated with urban water demand management was reviewed such as demand, supply, marginal benefit, marginal cost, economic efficiency, price elasticity, income elasticity, and affordability.

2. CURRENT WATER SUPPLY IN URBAN CHINA

In 1996-97, the 668 Chinese cities had a total population of 366 million living in urban area of China. The capacity of water production in urban China was 207 million m3/d and annual water supply was 47.6 billion m3, in which industrial supplies represented 53.04% (25.25 billion m3) of total, with domestic and others for the balance of 45.96% (17.54 billion m3), where 63.2% of water supply for residents. Per capita water consumption for domestic (including residents) was 213.4 liters and 95.16% of the urban population is served by municipalities and supplied by enterprises themselves.

3. WATER DEMAND TRENDS IN URBAN CHINA

It can be observed from Figure1, since 1978 the water demand in urban China could be divided into three phases based on the recorded data for water supply. The water consumption increased slowly in the first phase before 1984, the rapid increase occurred during 1984-1994 in the second phase because of rapid development of social and economy as well as lower water tariff and fell down slowly after 1994 in the third phase. Detailed are shown, in Figure1 and Table1.

4. PRICE AND INCOME ELASTICITY OF DEMAND FOR DOMESTIC USER

The ‘elasticity‘ refers to the extent that demand responds to changes in price or income. Knowing that demand reduces if price increases and demand increases if income increases, is all very well. However, for demand management, we must have some clear ideas of how much demand will change with a change in priceand how much demand will change with a change in income.
Data referring to water supply and demandare shown in Table2

Table2 Some Basic Information of Demand and Income

Note: household income is current prices.
Source from ‘China National Statistical Yearbooks‘ 1997 and ‘China Urban and Rural Construction Development Report‘.

5. CHARACTERISTICS OF PRICE ELASTICITY OF DEMAND FOR DOMESTIC

As water demand for domestic propose is mainly used for in-door usage, it has some characteristics as follows:

- Demand for water used for drinking, bathing, laundering and other fundamental needs is likely to be price-inelastic.
- Tariff charged represents small percentage comparison with other utility costs. Usually it is only less than1 % of household income in urban China. With incomes increasing and low water tariffs, households barely notice the financial impact of quite substantial increases in water tariff to do so.
- With income increases, the domestic consumer is willing to pay more water tariffand can afford it.

6. RESPONSIVENESS OF DEMAND TO PRICE CHANGE

In economics, demand is described as the inverse relationship between the price and the quantity consumed. The price elasticity of demand measures the percentage change in quantity demanded in response to the percentage change in price. That is, price elasticity measures the sensitivity of quantity consumed to price changes. The price elasticity of demand is a negative number. It can be expressed by the formula as follows:

where:

P_e= 0.0 Perfectly inelastic demand
0.0 > P_e -1.0 Relative inelastic demand
- 1.0 > P_e> - infinity Relative elastic demand
P_e = - infinity Perfectly elastic demand

Figure2 Demand Curve for Domestic Use

According to the law of supply and demand, demands tend to diminish with price increases. The price elasticity of demand for water tends to increase as price increas-es. As can be seen from Fig.-2, at higher prices, the price elasticity of demand for do-mestic use is more responsive to a change in price. When the price is 0.5 yuan/m3 the price elasticity is about -0.18, while at 4.0 yuan/m3 the price elasticity increases to -0.64. It can be calculated that average water price for domestic use is only 0.55 yuan/m3 based on the 135liters of per capita daily water consumption in 1997. The price elasticity for domestic use is only -0.18. According to international experience, there is a very low coefficient for domestic use. The interpretation of the value was that, for a 10 percent increase in the real price of water, demand would only fall by 1.8 percent. Similarly, if the real price fell by 10 percent, demand would rise by 1.8 perc-ent only. This finding shows that the water tariff for domestic use in 1997 is much low-er than the price for equilibrium demand and supply, and is also far lower than the long run marginal cost of supply (shown in Table5 as follow). If the price was adjusted to 0.9 yuan/m3 in 1997, that is, an average price increase of 64%, per capita daily water demand for domestic would decrease to 125 liters. The total domestic water consumption is likely to reduce by 2.8%. The detailed information is shown in Table3.

7. INCOME ELASTICITY OF DEMAND

The demand for urban water is not only affected by price but also by income. The income elasticity of demand is the responsiveness of the quantity demanded to a change in income. That is, income elasticity measures the sensitivity of quantity consumed in income changes. It can be expressed by the formula as follows:

A generalized urban water demand model can estimate the income elasticity. The parameters built into the model indicate income elasticity is 0.74 for a base-line average household income of around RMB 1550/month in 1997 and the income elasticity is 0.69 for highest household income of around RMB 2500/month. That is, if average household income increases by 10 percent, domestic water demand will increase by 7.4 percent. The findings show that average expenditures on water for domestic households is 0.45 percent only. Even for the lowest household income expenditures on water are much less than 1 percent, being only 0.53 percent of household income. These figures indicate when incomes are low, the income elasticity of demand has a higher sensitivity. A gradual increase in price can be possible and affordable for domestic water users. The income elasticity of demand for domestic water supply is indicated in Table 4.

Economic parameters of water demand management for domestic use in urban China[II]