STATE PUBLIC UTILITY regulation of electric power generation, transmission, and distribution and of local telephony represents a contract between the state and the regulated company. The economic functions of the regulatory contract, as well as the legal duties and remedies associated with it, are identical to those of a contract between private parties.

ECONOMIC FOUNDATIONS OF THE REGULATORY CONTRACT

Consumers and businesses voluntarily participate in a market transaction only if they receive gains from trade—that is, only if the transaction yields positive net benefits for them. A supplier will not invest in a transaction unless he expects the returns from the transaction to cover all economic costs, including a competitive return to invested capital. That principle is summarized in Armen A. Alchian's classic definition of cost: “In economics, the cost of an event is the highest-valued opportunity necessarily forsaken.” The supplier's costs of investing in the transaction include the highest net benefit of all opportunities forgone, known as opportunity cost.

Cost Recovery for Transaction-Specific Investment

Cost recovery is an essential element of contract law. A contract must provide consideration to each of the parties, which implies that those incurring costs must expect to recover those costs, including a return to invested capital. Victor P. Goldberg, for example, has noted of contracts generally: