Fairness in Public-utility Regulation: A Theory

Regulators routinely and systematically depart from policy prescriptions that are soundly based in conventional economic theory. In doing so, they often appeal to notions of fairness, justice, or reasonableness. Economists have historically struggled with these notions, which seem to be separate from, or in conflict with, conventional economic efficiency. This paper identifies five stylised facts about public attitudes to fairness in utility pricing, and argues that these stylised facts can be explained as an implicit attempt to protect the sunk investments of consumers in a natural monopoly's services. Thus the paper suggests that the notion of fairness is not in conflict with the conventional notion of economic efficiency, but can be seen as consistent with the desire to promote sunk investment by the monopolist and its customers.