Does Non-Linear Pricing Work? - Evidence from Residential Water Consumption in GuangDong Province

Abstract

Non-linear pricing has been widely used in many aspects of daily life, such as water, gas and tax rates. Nevertheless, aware of the complexity of pricing signals, consumers might not respond in accordance with what traditional pricing theory predicts, which would in turn generate misguiding signals from the pricing policies enacted by the government. Moreover, it also remains controversial whether non-linear pricing would discourage consumption. Based on models developed by Ito (2014), we employ both macro water pricing data and the monthly water consumption data of individual households from several cities in GuangDong Province to investigate prices as consumers perceived them. The empirical evidence reveals that the water consumption level of an individual household in any period is mainly contingent upon the average price level in the previous period, not upon the marginal prices or expected marginal prices in that period. We calculate this two-period price elasticity as -0.24. This implies that the implementation of a non-linear water pricing strategy (a ladder water-pricing strategy) fails to lower the water consumption of individual households, but raising the level of average pricing manages to do so. Our empirical results are also robust among households with different income levels and educational levels as well as different levels of water use. The conclusions to be drawn from this study can have far-reaching implications for tax policy designs, energy pricing designs, telecommunication menu pricing strategy formulations, and so on.

Keywords: Nonlinear Pricing, Water Consumptions, Perceived Prices

JEL Classification: D12, L11, L94