An Infinite Horizon Contract for Demand Management in Urban Water Systems with Two Consumers

R K. Amit, Indian Institute of Technology - Kanpur
Parthasarathy Ramachandran, Indian Institute of Science, Bangalore

Abstract

In public utilities, under supply constraints, fairness considerations introduce negative externalities and lead to market failure. Coase theorem states that the bargaining process can eliminate any inefficiency due to externalities. This paper characterizes an infinite horizon contract with two consumers, within the agency theory framework, that replicates the infinite horizon alternating bargaining model to mitigate the market failure due to fairness considerations. The concept of firm supply is introduced in urban water supply systems. Firm supply is the largest quantity of water available that is dependable at all times. The paper discusses the fair allocation of the firm supply between the consumers; and the consumers are induced to consume water at their allocated shares in each time-period based on the incentives offered by the public utility. The dynamic contract, presented in this paper, is shown to be economically efficient and achieves both endstate and procedural fairness.