do not reflect the full social cost because they do not include the value of water, which is usually assigned to a municipal utility with no cost. Second, since demand and customer preference are considered exogenous in cost calculation, they are not able to capture the consumers’ value of water and related social welfare (Renzetti 1991; Garcia and Reynaud 2004). Third, it is difficult to estimate actual domestic household water use, even based on actual water drawn, because there may be water loss due to leakage or transportation (Zhou and Tol 2005). In addition to these common problems in assumptions, each pricing mechanism has its own shortcomings.<sup>3</sup> More importantly, supply-side strategies are unable to take into account social equity or affordability concerns, while demand-side strategies are able to capture the price level the public considers “acceptable” or “affordable.” Demand-side strategies are thus more useful in assisting decision makers in setting water prices.

Many countries and cities have used the willingness to pay (WTP) for water services to determine desirable water prices. WTP reveals consumers’ willingness to forgo certain benefits in exchange for others. This concept is widely used in measuring the value of environmental benefits or public goods, and is usually used to estimate how much the public is willing to sacrifice in exchange for better supplies of a public good.

When a water supplier decides to improve its water supply service, it has to consider the public’s ability to afford higher prices when in deciding how much to invest. Whether a reform can be successful largely depends on how much more consumers are willing to pay to purchase the improved service. The WTP pricing scheme can help decision makers capture and estimate consumer demand for improved services (Pattanayk et al. 2006). In estimating WTP, economists can apply an indirect approach by observing the behavior of consumers and then calculating the WTP based on the time and money forgone to obtain certain goods. Alternatively, they can use a direct approach such as the contingent valuation method (Raje et al. 2002).

The contingent valuation method (CVM) is a straightforward measurement to determine the public’s WTP based on the consumer demand theory. It has been widely used and reviewed (Mitchell and Carson 1989). There are several approaches, including the traditional open-ended method, the dichotomous-choice method, and the multiplebounded discrete choice stochastic approach (Wang and Whittington 2005). CVM is a stated preference method that minimizes the expenditure of the consumer subject to his utility constraint. Despite criticism, it is used in many resource valuation studies. CVMderived values such as WTP are contingent on the level of information provided by the the respondents and the extent of information provided by the survey. However, poorly designed or implemented questions may cause bias in the results.

By studying the attitude of the public toward various combinations of a higher price and improved service, CVM has the advantage of capturing the public’s reaction to each pricing level. As a result, the price maker can better balance the goal of satisfying the

> 3 For example, both long-run and short-run marginal cost pricing, although it is thought to be able to achieve the maximized social welfare, has some practical difficulties (Garcia and Reynaud 2004).