When water is cheap, you may see people spraying down a sidewalk during a drought when they could use a broom. Raise the price and their behavior changes.
And if you're worried that people can't afford water for they personal use, what I advocated was each citizen getting paid their share of the water revenue.
And that actually would go UP during a drought, more than the cost of their own direct personal use. That's because INDUSTRY uses the most water.
They would, of course, pay more for the products of industry.
And things like shipping bottled water from California during a drought might become a thing of the past. As it probably should.
Another way to model this which some people will prefer and others will think is worse is that you just charge the correct/high rate for water at all scales but then hand people cash to subsidize their expected requirement for water, which they could choose to spend on water or which they could spend on something else, which maintains incentives to use less than the expected amount of water but which also doesn't cause weird effects in the market itself where people start trying to sell each other water from their different rate brackets.
(edit: Actually, I guess this is sort of how California has been trying to deal with this, with penalties to larger users... but in practice these penalties are of course being given to the people already not using much water and are not being levied against the richer people who are using tons of water :/. Here is an article about this from the New York Times, "In California, Stingy Water Users Are Fined in Drought, While the Rich Soak".)
http://www.nytimes.com/2015/11/22/us/stingy-water-users-in-f...
Its much simpler to have one price per water source and pay citizens their share of the proceeds after costs.
I understand that this is not your primary point, and I even understand the sense in which it is true, but I think it's short-sighted.
People will die without oil, electricity and silicon chips because we've come to depend on them for such things as medicine, agriculture, waste processing, etc.
Things like your run-of-the-mill plastics are very much a matter of life and death.
I remember grade school being so cold in the winter because they used gas to heat the school. The US only used domestic natural gas back then, so it couldn't be blamed on some embargo.
If everybody in the Middle East were paying a market price for water, there would be less conflict, not more.
Instead of having to fight for a resource, they compete to sell it to you.
I don't think the supply of ground water and the demand for it vary wildly. And that is what market prices are based on.
But a sudden change in prices would definitely occur when it is depleted.
Rain water is a different thing. The supply varies greatly. But it is also completely renewable. Industries that use it should adapt to its potential scarcity and prices help to do that.
You can't get industry to conserve without them. Because, as you pointed out, they don't have the same incentives as governments do. And industry is the biggest user in many places.
Every person gets a free daily "survival" quota. Above that, you pay market. The latter subsidises the former. You pay less for your drinking water and more for your lawns and alfalfa.