Taken from the book, Pricing on Purpose by Ron Baker

The value of anything depends on the margin-the edge, the addition to value. The margin is what happens next. The most difficult decisions we confront are marginal decisions. For instance, few of us waste any time deciding whether or not we have to work; the question is should we work more or fewer hours? A country does not debate whether or not to have a military defence, but rather how big or small it should be. If you were to pile straws onto the back of a camel, eventually the camel’s back would break. It might seem reasonable to blame all the straws, but if straws could talk (& think) they would blame the marginal straw-that is, the last one.  After all, everything was fine until it got there.

Besides being abundant, water tends to be priced based on the marginal satisfaction of the last litre consumed. According to Gossen’s law: The market price is always determined by what the last unit of a product is worth to people. While the first few litres may be vital for your survival, the water used to shower, flush the toilet, & wash the dishes is less valuable. Less valuable still is the water used to wash your dog, your car & clean your driveway. The market price for water reflects the last uses of the good for the aggregate of all consumers of water. On the other hand, the marginal satisfaction of one more diamond tends to be very high.

If water companies knew you were dehydrated in the desert they would be able to charge a higher price for those first vital litres consumed, & then gradually adjust the price downward to reflect the less valuable marginal litres. Since they do not possess this information-the cost of doing so would be prohibitive- the aggregate market price for water tends to be based on its marginal value.