Prices vs quantities with risk aversion

Weitzman (1974) asks whether we should regulate a good by fixing quantity or by fixing price when cost and benefit are uncertain. His welfare criterion—expected aggregate surplus—tacitly imposes two strong quasilinearity assumptions on a consumer’s preferences: neutrality with respect to income risk; and absence of income effects on the valuation of the good. Both are matters of first-order importance for the evaluation of allocations under uncertainty. Here I ask how risk aversion affects the choice between the two when the regulated good is a public good. I give conditions for welfare—in the form of the sum of certainty equivalents—to be higher for a fixed price; the conditions allow arbitrarily-high levels of risk aversion, even though consumers bear no uncertainty about quantity or income with a fixed quantity. The conclusion depends crucially on benefit uncertainty, present but irrelevant in Weitzman. An unintended consequence is a surprising new argument against quantity regulation: risk aversion. • I ask how consumer risk aversion affects Weitzman’s (1974) celebrated result comparing price vs quantity regulation. • I give conditions for welfare—in the form of the sum of certainty equivalents—to be higher for a fixed price. • The conditions allow arbitrarily-high levels of risk aversion, even though consumers bear no uncertainty about quantity or income with a fixed quantity. • The conclusion depends crucially on benefit uncertainty, present but irrelevant in Weitzman.