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n w ker rationing in response to drought. Using estimates of expected marginal prices that vary both across and within markets, we estimate price elasticities specific to indoor and outdoor water use. Our results sug-gest that current policies do target water uses that households, themselves, are most willing to forgo. Nevertheless, we find that rationing outdoor water in cities has costly welfare implications, primarily due to household heterogeneity in willingness-to-pay for scarce water. We find that replacing rationing policies with a market-clearing ‘‘drought price’ ’ would result in welfare gains of more than 29 % of what d to al prices to reflect scarcity rents during periods of excess demand, policy makers have mandated the curtailment of certain uses, pri-marily outdoor watering, requiring the same limitations on con-sumption of all households. If indoor demand is not perfectly inelastic, or households have heterogeneous willingness-to-pay for scarce water, a price-based approach to drought policy has a theoretical welfare advantage over water rationing. reactions to price increases, on average, as outdoor demand is much more price elastic than indoor use. However, the real advan-tage of market-based approaches lies in their accommodation of heterogeneous marginal benefits. When regulators impose identi-cal frequency of outdoor watering, shadow prices for the marginal unit of water may vary greatly among households. Our estimates of separate end-use elasticities for four heterogeneous household groups, based on income and lot size, suggest that households are heterogeneous in these markets. We estimate shadow prices for each consumer, and utility-level market-clearing prices under four drought policy scenarios of increasing stringency. We the