Modeling residential water demand: An approach based on household demand systems

Abstract

Most estimations of residential water demand are based on single-equation models that rely on assumptions that are most often not compatible with the fundamental principles of consumer theory. In this paper, we relax these assumptions by using a more flexible system of demand estimation, the Quadratic Almost Ideal Demand System (QUAIDS) (Banks et al., 1997) and reveal the existence in our sample of substitution and complementary patterns as well as non-linearities in Engel curves for water consumption. Water demand would not be, therefore, linear in income and separable from other goods consumed within the household. In this context the QUAIDS functional specification is expected to be more consistent with observed consumer behavior. Our results seem to confirm this expectation; when compared to the linear, log-linear and double-log models commonly used in water demand estimation, QUAIDS seems to produce a better overall fit and a better fit to the asymmetric shape of the real distribution of water consumption. This has important implications in terms of public policy, as it allows to explore how water policies interact with other goods consumed within the household (e.g. water-energy nexus or efficient household appliances). Furthermore, differential responses to pricing policies and taxes across the income distribution can be considered, thus contributing to avoid undesired redistributive effects and water poverty.

Keywords: Consumer welfare; Cross-price elasticity; Pricing policies; QUAIDS; Residential water demand; Water management.