question:
Texas minimum construction standards require all plumbing fixtures to be WaterSense certified. Examples of requirements under these standards include low-flow faucets, shower heads, and toilets.
For the sake of argument, let’s assume that before the low-flow toilet requirement went into effect, it cost $250 to install a normal-flow toilet. Also assume that the regulation costs an additional $100 to install a low-flow toilet, and the customer appreciates the savings of $25 per low-flow toilet.
Show how the demand and supply curves for toilets change as a result of this law. What will be the price of a new toilet (giving a variety of new prices will suffice)? Who benefits from the law? The plumber, his customer, both, or neither? Justify your answer.
Solved:
I used this question in my classroom to highlight some ideas. First, it is not clear that product quality obligations necessarily enrich consumers’ lives. I say unclear because such obligations may be aimed at addressing externalities.
For example, my former colleague at Texas Tech University, Adam Martin, once pointed out that West Texas, like several other parts of the American West, relies on the Ogallala Aquifer for water. No one owns the aquifer, so pricing its use is difficult. In this case, we may experience a classic tragedy as a result of the commons. When using water, each person considers only his own costs, not the total social costs. As a result, aquifers can be rapidly depleted. However, my answer is to ignore this possibility.
Another reason I ask this question in the classroom is that if consumers truly value the additional quality required by the mandate, companies should already have an incentive to provide it. Because you can profit from doing so. This question also provides an opportunity to discuss how delegation occurs. In effect, this regulation acts like a tax, but instead of providing revenue to the government, in this case to the suppliers of low-flow toilets, and more generally to those who provide additional quality. Like taxes, this obligation creates a deadweight loss.
Since consumers value the water savings of low-flow toilets at $25 per toilet, we can assume that the demand for low-flow toilets is $25 more than the demand for regular toilets. By the same logic, we can think of this obligation as reducing supply by $100. There will be an additional charge for the plumber to install a low flow toilet. Since the decrease in supply is greater than the increase in demand, fewer toilets will be installed and the market price will increase by some amount between $25 and $100. Things are getting worse for both plumbers and their customers. After plumbers cover their high costs, their net revenue is reduced and customers end up paying more than the improvements are worth. As a result, deadweight loss occurs, reflecting the reduction in mutually beneficial transactions that would have occurred in the absence of the obligation.
You can use the supply and demand diagram below to illustrate this idea.
Image by Brian P. Cutsinger
The initial demand and supply curves, shown in black, reflect market conditions before the mandate took effect. This obligation shifts the supply curve to the left by the additional cost of installing low-flow toilets, as shown by the red supply curve S’. The red demand curve D’ reflects consumer demand for low-flow toilets. The vertical distance between D’ and the initial demand curve D represents the added value that consumers place on water savings from low-flow toilets.
The initial price of a toilet is said to be $250, so the mandate should raise the equilibrium price. How much it increases depends on the elasticity of demand and supply, but we know that the new price will be somewhere between $275 (if demand is perfectly elastic) and $350 (if supply is perfectly elastic).
