Quasilinearity and Its Discontents: Public-Good Regulation with Consumer Risk Aversion and Income Effects

In the partial-equilibrium literature on regulation, the usual measure of social welfare is a weighted average of expected profit and expected consumers' surplus. It is justified if two strong quasilinearity assumptions hold on each consumer's von Neumann–Morgenstern utility: income-risk neutrality and no income effects, assumptions that rule out matters of first-order importance for regulation under uncertainty. I review and extend known results on how risk aversion and income effects change Weitzman’s classic result on prices versus quantities. And I present preliminary results on an optimal regulatory policy for risk-averse consumers, unconstrained to just prices or quantities.