Academics and policy makers have widely acknowledged that the price of water has been substantially below the cost of providing water services. Pressure on utilities’ budgets has led to a growing acceptance of the need for Full Cost Recovery (FCR). Today, in most developed regimes at least, customers are expected to pay for the costs of their water services.

The widespread acceptance of FCR has brought with it a new pricing challenge—not just ensuring that customers pay for the services that they receive but that customers consume an efficient quantity of water services. Utilities adopting more expensive technologies at the margin (such as the expansion of desalination plants in Australia) may have incremental costs far outstripping their historical average costs of service and the prices they charge to customers. Moreover, rising water scarcity, increasing bills and economic pressures on the population as a whole, have resulted in increasing scrutiny of tariffs, even in water-rich jurisdictions like the UK.

Economic theory suggests that marginal cost pricing is the key to ensuring customers make efficient consumption decisions. This paper focuses its attention on the use of marginal cost concepts in water tariffs in theory and in practice.