Endogenous Factor-Commodity Price Structure by Factor Endowments

In this paper, we show that the rate structure endogeneity may result in a misspecification of the residential water demand function. We propose to solve this endogeneity problem by estimating a probabilistic model describing how water rates are chosen by local communities. This model is estimated on a sample of Canadian local communities. We first show that the pricing structure choice reflects efficiency considerations, equity concerns, and, in some cases, a strategy of price discrimination across consumers by Canadian communities. Hence estimating the residential water demand without taking into account the pricing structures' endogeneity leads to a biased estimation of price and income elasticities. We also demonstrate that the pricing structure per se plays a significant role in influencing price responsiveness of Canadian residential consumers.