Guidelines Glossary

'Marginal cost pricing' expresses the theory that the net benefits of an economic activity are maximised when prices are equal to the marginal cost of production. This is because prices measure consumers’ marginal willingness to pay, and therefore the value, of a commodity or service. The marginal cost is the quantity of resources, which must be employed to produce a single extra unit of the commodity. When price equals marginal cost, it indicates that the cost of the marginal unit of production is just equal to, and therefore justified by, the value of the extra consumption. In the case of water resources, the ‘cost of production’ should be interpreted to include the impact on the environment. Damage to the environment can lower welfare directly (e.g. through reduced amenity), or indirectly, through the need to spend more on water treatment. Also, any current use must reduce the amount of water available for use in future periods. This would apply to any store of water, such as an aquifer or lake, being used in excess of its recharge rate. Continued exploitation must at some time lead to exhaustion. Hence, current use of the resource has an opportunity cost which is the cost of use foregone in the future. Various formulae exist on which marginal cost pricing policies can be based, which take into account the indivisibilities, which are a feature of water resources, investment.

Further information: Pricing of Water Services. OECD, 1987.

Systems of metering for calculating water consumption, and thereby charges owed by the customer per unit of water consumed, are needed in cases where charges or tariffs for water are not set at a flat rate per user. However, it is important to recognise that metering is expensive to install and operate efficiently, and that users are likely to reduce their usage, so that it may not be economic – however apparently desirable – to install a metering system. Any decision to install metering will have to take many factors into account: the value and scarcity/abundance of water; the cost of installing meters, maintaining their security, staffing their inspection, billing customers, etc.; possible customer reactions; the desirability and practicalities of introducing a two-tier payment system, whereby above a certain level, price per unit increases, thus helping reduce waste and increase revenues. Most OECD countries, and a growing number of other countries, use metering for urban domestic water consumption. (See also Tariff structures.)

Monitoring is the systematic and continuous observation of actual events, and their comparison with the planned situation or outcome. Monitoring is necessary both to check the actual project performance on an ongoing basis, and to measure whether it has achieved the objectives it was designed for. In order for monitoring to be undertaken, indicators are needed about which data can be collected on a regular basis. The selection of useful indicators is critical to the quality of data collected. (See also Chapter 13, Monitoring Indicators.)