Decentralized Water Pricing and Water Pollution Taxation Model in the Presence of Uncertainties, Incomplete and Asymmetric Information (WAP)

The decentralized water pricing methodology addresses main challenges of sharing a common resource – water - among the competing users in an efficient and fair way and a problem of preserving the water quality.


Water pricing is an example of financial measures to control or reduce water consumption by different users and systems. In the water framework directive (WFD), it is required that Member States, by 2010, introduce water-pricing policies that create incentives for efficient use of water resources. The water pricing is supposed to recover the true costs of water and water services. There are major challenges associated with the development of fair water pricing mechanisms. Inadequate water pricing may lead to imbalanced production in different sectors of national economies. Thus, all industries are very sensitive to water supply and treatment costs. Agriculture, which is still widely subsidized, pays much lower prices than the other main sectors (CAP). Increased prices are likely to produce a profound effect on water users especially where water use are metered. Domestic and industrial supplies are now metered in most countries, whilst irrigation supplies are metered only in a few. The difficulties with water pricing foremost concern the lack of exact knowledge about the utility functions of the water users and the incomplete information about the amounts of water required. The proposed approach to determine the price of water is based on a decentralized water pricing methodology which does not require water users/systems to reveal their private information.

Methodology/How the model works/Data generation

The procedure describes the market price formation process for a common resource – water. Formally, if all information about the water users is available, e.g. the utility functions, demands, uncertainties, etc., the water price may be derived by a central planner as the shadow price (the dual value) of the optimal water-use program. In the absence of such information, it is impossible for a central planner to find such shadow price. The water users may not want to reveal their utility functions, demands, and uncertainties associated with the water use.  The proposed approach determines the water prices in a decentralized manner without requiring water users to reveal or exchange their private information. The water pricing methodology is augmented with the water quality constraints to determine optimal level of water pollution tax. The methodology of water pricing in the presence of uncertainties and incomplete information is a rather general scheme which, in fact, has analogues with Walras law describing the dynamics of prices under specific market conditions, which finally converge to the optimal (equilibrium) prices. 


The model has been applied to the agricultural region around the Aral Sea to determine how water policies may affect agricultural production and improve environmental conditions (Ermoliev et al. 1995). Then, the model has been advanced and applied for the analysis of pollution abatement strategies (Ermoliev et al. 1996, 2000; Godal et al. 2003). Later, the methodology of decentralized pricing under uncertainties, incomplete and asymmetric information has been used for the development of a prototype emission trading model in the framework of a joint GGI project at IIASA[1] (Ermolieva et al. 2010, Ermolieva et al. 2012).  

Spatial representation

The model can operate at national, subnational, regional, district, households  levels.

The model is available on request.


Decentralized water pricing and water pollution taxation model in the presence of uncertainties, incomplete and asymmetric information (WAP), IIASA, Laxenburg, Austria

[1] The integrated emission trading and abatement model has been developed within a framework of a GGI project “A prototype model of robust emissions trading market under uncertainties”, a collaborative activity of IIASA’s Greenhouse Gas Initiative between MAGG (former APD), ESM (former LUC and FOR), ASA (former IME) programs. 

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Last edited: 22 July 2013


Tatiana Ermolieva

Research Scholar

Integrated Biosphere Futures Research Group

T +43(0) 2236 807 581

Model & Data Access

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International Institute for Applied Systems Analysis (IIASA)
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