Willingness to pay under uncertainty

In this dissertation I apply recent advances in decision theory under uncertainty to consumer welfare analysis in a simple two-stage model. The consumer is assumed to consume two commodities in the second stage. One is a risk free-commodity in the sense that the consumer is certain of its price and the quantity available in the second stage. The other is a risky commodity. because the consumer is uncertain of either its price or its quantity in the second stage. In the first stage, the consumer can reduce the risk of the risky commodity by promising to give up some of the risk-free commodity in the second stage. The amount given up is the consumer's willingness to pay for the reduction in risk.;We consider two different types of risky commodities and derive the consumer's willingness to pay for these commodities. One is a risky commodity such as a unique national treasure. If it is destroyed or lost, it is impossible to recover the damage by spending money. Under such circumstance, we say that the consumer faces consumption uncertainty about the risky commodity.;The other type of commodity studied is one that is subject to price uncertainty. In this case the consumer can obtain some of the risky commodity by sacrificing the risk-free commodity in the second stage. As an example of this commodity, consider a good sold in a grocery store. In general, the consumer determines his or her consumption level of the good after he or she finds out the price of the good. The consumer can substitute money for the good after the price is revealed in stage two.;We derive the consumer's willingness to pay for these two different risky commodities and show that the type of commodity is crucial. In particular, a risk averse consumer is generally willing to pay a positive amount to avoid consumption uncertainty but not to avoid price uncertainty. These results hold in expected utility theory but may not in state dependent utility theory. We explore the reasons for the differences due to type of uncertainty and type of utility function. We then apply our findings to cost-benefit analysis and discuss public policy implications.