REGULATED
INDUSTRIES
IN A NUTSHELL
FOURTH EDITION
By
RICHARD 1. PIERCE, JR.
Lyle T. Alverson Professor of Law
George Washington Un iversi ty
and
ERNEST GELLHORN
Professor of Law,
George Mason Universi ty
WFSf
GROUP
ST. PAUL, MINN.
1999
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CHAPTER VI
RATES TO CUSTOMERS: PROBLEMS OF DISCRIMINATION
AND CLASSIFICATION
A. INTRODUCTION
After an agency determines the aggregate revenue requirement a firm will be allowed an opportunitY to earn, it must determine the rates the firm is
authorized to charge in an effort to earn the allowed revenue. Typically, the firm proposes a specifie set of rates to individual customers or to classes
of customers with common characteristics, subject
to review by the agency. In many cases, no party
objects to the rate schedules proposed by the firm as
long as they appear to be consistent with its allowed
revenue requirements. If, however, any party objects to the proposed rate schedules, most agencies
have a statutory duty to review the specifie rates,
not only to ensure that they are consistent with
allowed revenue requirements, but also to determine that the relationship among the rates is appropriate.
The statutes under which most agencies regulate
prohibit relationships between rates that are unduly discriminatory. Indeed, sorne major regulatory
schemes were adopted for the primary purpose of
165
166
DISCRIMINATION & CLASSIFICATION
Ch. 6
eliminating ùndue discrimination in rates. See, e.g.,
Louisville & Nashville R Co. v. United States, 282
U.S. 740 (1931). Under most regulatory schemes, a
rate is unlawful if it discriminates unduly against
any person, any cJass of customer , or any locality.
These statutes also prohibit undue discrimination
in the other terms and conditions under which a
regulated flrm provides service. See, e.g., North
Carolina v. Federal Energy Regulatory Commission,
584 F.2d 1003 (D.C.Cir.1978) (holding unduly dis·
criminatory an order allocating natural gas among
geogTaphical areas).
A rate is not unlawful merely because it differs
from sorne other rate; only rate differentials that
discriminate unduly, or for insufficient reasons, are
unlawful. ICC v. Baltimore & Ohio R R , 145 U.S.
263 (1892). A legal conclusion of undue discrimina·
tion can be based on a flnding that one customer
can purchase the same product as another customer
at a different rate, unless there are distinctions
between the two customers sufficient to justify the
difIerence in rates. Rate differentials can be justi·
fled on many bases, but the persona! identity of the
customers is never sufficient alone to justify a dif·
ference in rates. Wight v. United States, 167 U.S.
512 (1897). Sorne agencies and courts also conclude
that undue discrimination exists when there is a
rate differential disproportionate to anY difference
in the costs of making a product available, uniess
the differential can be explained adequately on oth·
el' grounds. See, e.g., Pittsburgh-Philadelphia NoReservation Fare Investigation, 34 C.A.B. 508
Sec.
B
UNDUE DISCRIMINATION
167
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(1961). Other agencies and courts, however, are not
willing to consider cases of disproportionate rela·
tionships between costs and rates; they consider
their responsibilities limited to review of situations
in which different rates are charged for like prod·
ucts. See, e.g., City of Boscobel v. Wisconsin Power
& Light Co., 52 P.U.R.3d 264 (Wis.P.S.C.1964).
B. REASONS FOR PROHIDITING
UNDUE DISCRIMINATION
The traditional prohibition of unduly discrimina·
tory rates is premised on the need to avoid five
perceived evils-unfairness, burdens imposed on
sorne consumers as a result of disproportionately
low rates charged to other consumers, predatory
pricing, "second best" problems of resource misallo·
cation, and unjustified transfers of wealth from
consumers to regulated firms. We will summarize
each argument briefly after discussing the economic
reasons a firm might choose to charge rates dispro·
portionate to its costs of providing different prod·
ucts or serving different customers.
A firm rarely is neutral concerning the relation·
ships among its rates even after an agency has
determined the firm 's allowed revenue require·
ments. There is only one combination of rates
through which a firm can maximize its actual reve·
nues. To understand this fundamerital truism re·
quires an introduction to the concept of price elas·
ticity of demand. 1 The quantity demanded of any
1. See also the discussion of demand in Chapter 2.
Sec. C
WHAT IS UNDUE1
177
would not be willing to sell a product at a rat~ equal
to marginal cost .· Therefore, sorne customers who
are willing to purchase the product at that rate
would be unable to do so. With differential pricing,
at least sorne of the customers who are willing to
purchase the product at a rate between marginal
cost and the uniform rate the firm otherwise would
charge ail consumers will be able to obtain the
product.
In summary, there are many theories underlying
the prohibition against undue discrimination in
rates, none of which find c1ear support in economic
theory. This diverse and murky theoretical foundation helps to explain the difficulty agencies and
courts experience in determining what discrimination is undue.
C. WHAT DISCRIMINATION
IS UNDUE?
In the typical case, a party a1leging undue discrimination must establish that the r ate charged
one customer, class of customers, or geographical
area is different from the rate charged another
customer, class of customers, or geographical area
for the same product, and that there is no legally
sufficient justification for the rate differential. A
somewhat broader formulation of the standard, accepted by sorne agencies and reviewing courts, permits a conclusion of undue discrimination based
upon disproportionality in the ratio of cost to the
2.
See the discussion of monopoly pricing in section 2A2b.
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DISCRIMINATION & CLASSIFICATION
Ch. 6
price charged various customers, classes of customers, or geographical areas, if there is no legally
sufficient justification for the disproportionaIity.
Under either test, the rate differentiaI or disproportionality between prices and costs constitutes undue
discrimination only if the firm is unable to justify
the differential or disproportionality to the satisfaction of the agency or reviewing court.
A rate differential usuaIly can be justified to the
satisfaction of an agency or court by demonstrating
that the differential in rates is based on a corresponding differentiaI in costs. Sorne agencies resolve
this issue definitionally by concluding that the rates
are not applicable to the same product. In addition
sorne, though not aIl, agencies and reviewing courts
are satisfied that a rate differentiaI or rate/cost
disproportionaIity is sufficiently justified if it is
based on differences in the priee elasticity of demand of the respective customers, classes of customers, or geographical areas.
1.
COST-BASED RATE DIFFERENTIALS
Determining whether a rate differentiaI is justified by differences in the costs of providing service
to various customers, classes of customers, or geographie areas is part science and part art. As a
preliminary matter, it is expensive and time-consuming to attempt to determine the cost of serving
particular eus tom ers or groups of customers. For
that reason, agencies and reviewing courts often
permit the rate schedules proposed by firms to go