Water supply and demand
Why prices for water are important, and what can happen when those prices are interfered with.
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1) The figure (at 3:00) is WRONG. A subsidy does NOT shift the D curve; it closes the wedge (shown in the first drawing of the fig, where Q was greater but P_d was less than P_s).
2) Most agricultural water (esp. groundwater) is "own supply" and the subsidies are more complicated (e.g., opportunity cost due to some having a RIGHT to water)
3) Most urban water is sold at average, not marginal, cost, which means that the utility ends up supplying water at prices that are below the cost of production. HUGE problem.
4) The scenario in your fig (at 5:45) does not always happen, since fixed revenues can be used to subsidize marginal costs of production. The FC/VC vs FR/VR issue is very important in water economics.
5) But you're RIGHT about who gets water (powerful) w price controls.
6) Don't confuse water tariffs (retail service) with water rights (wholesale markets). They are totally separate.
Don't fixed and variable costs come into the picture? Following the Walkerton e coli tragedy water became metered. Over the next ten years, water usage has continually gone down and water rates have continually gone up to cover the fixed treatment, maintenance and salary costs. What happened to the economy of scale argument presented for watermelons?
Yes, FC and VC matter. Most people miss that, but the "problem" results from FC NOT matching FR (monthly charge) at utilities. That's why you get the problem you noted. Here's my soln: http://www.aguanomics.com/2011/09/time-to-dump-increasing-block-rates.html
I really made a bad question. Obviously if the subsidy is given to the consumer, the effect is an increase of the price of water. The subsidy to the producer, instead decreases the price of water. It is the quantity consumed that increases either way.
So the formulation of the practice question is a little ambiguous, albeit not wrong.