In telecommunications, regulators turn increasingly to the nebulous term known as "cost-based" to set pricing policy. An example is the new Telecommunications Act of 1996 (Act), whose pricing standards for interconnection and network element charges stipulate that the just and reasonable rate for the interconnection of facilities and equipment should be "based on the cost ... of providing the interconnection or network element,"1 and "may include a reasonable profit."2 The notion of "cost-based rates" also surfaces in many state regulatory proceedings.3
To economists, however, cost bears no universal or formulaic relationship to price. Though it is not a term of art, "cost-based pricing" for the practicing economist usually denotes a price that relies on incremental cost as a price floor, and that exceeds this floor in efficient ways based on market information and other variables.4 But regulators often use the term "cost-based rates" to describe the setting of prices via some sort of formula, using cost data as the primary determinant. That notion bears scrutiny. While cost-based pricing itself is not objectionable, formula-based pricing should give cause for complaint when it is thinly disguised as "cost-based pricing."