Setting the price for public services.

Many services, such as garbage collection or water, are provided by local governments. This places taxpayers in a interesting position – they are the purchasers of the service, and, through the taxes they pay if the services are under-priced, they are in the same position as the owners of a private firm – they are the ones who suffer any loss if the service is not priced correctly. At what price should governments offer services? The marginal cost (supply) and demand relationship that is appropriate to perfectly competitive firms is helpful in understand how government services should be priced.

Exploration: How can we determine an appropriate price for a municipal services?

Example 7.4 explores the relationship between the cost of supplying water from different sources and the appropriate price to be charged for the water. The authors argue that in order for the citizens of Gainesville to enjoy the largest possible economic surplus, they should each pay the cost of producing the last gallon of water, in this case 4.0 cents/gallon.

1. Locate the demand for water at 4¢. The model indicates that people are willing to buy 4,000,000 gallons per day at this price. Why should the people who get water from the 0.2¢ per gallon source be charged 4.0¢?
   
2. If, on the other hand, the usage of water falls significantly to, let's say 2,000,000 gallons per day, how much should the city of Gainesville charge for water?
   
3. Why would we not charge the 0.8¢ marginal cost?
   
4. Under what conditions would the 0.8¢ per gallon price NOT result in a water shortage?
   

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Exercise picked up from the 2e Economics textbook.