10. Many parts of California experienced a severe drought in the late 1980s and early 1990s.

a. Use a diagram of the water market to show the effects of the drought on the equilibrium price and quantity of water.

b. Many communities did not allow the price of water to change, however. What is the effect of this policy on the water market? Show on your diagram any surplus or shortage that arises.

c. A 1991 op-ed piece in The Wall Street Journal stated that “all Los Angeles residents are required to cut their water usage by 10 percent as of March 1 and another 5 percent starting May 1, based on their 1986 consumption levels.” The author criticized this policy on both efficiency and equity grounds, saying “not only does such a policy reward families who ‘wasted’ more water back in 1986, it does little to encourage consumers who could make more drastic reductions, [and] . . . punishes consumers who cannot so readily reduce their water use.” In what way is the Los Angeles system for allocating water inefficient? In what way does the system seem unfair?

d. Suppose instead that Los Angeles allowed the price of water to increase until the quantity demanded equaled the quantity supplied. Would the resulting allocation of water be more efficient? In your view, would it be more or less fair than the proportionate reductions in water use mentioned in the newspaper article? What could be done to make the market solution more fair?