The D.C. Public Service Commission is being asked to choose between reality and theory in deciding whether to permit Potomac Electric Power Co. to pass on to D.C. customers part of the costs of building new generating plants. The arguments being presented to the PSC will provide a demanding test of the panel's recognition of the need for radically different regulatory policies in a new era of demand and economic growth.

Based on current projections and indicators in the local economy, it appears that reality weighs heavily in Pepco's favor as it seeks to add new generating capacity. Elements within the PSC and the Office of Peoples Counsel, which represents electric power consumers before the PSC, are relying heavily on theory to thwart Pepco's plans.

Prior confrontations have been marked by the usually predictable arguments centering on the mundane rate-making process presided over for generations by regulators. The PSC, like other electric utility regulatory bodies, did its best -- or worst -- to sort out the usual arguments over such issues as fair rates of return on investment, construction costs, fuel rates and power demand estimates.

The electric utility industry has entered a new era, however, and while regulatory agencies still are charged essentially with setting rates and ensuring cost-effective delivery of power to ratepayers, wild shifts in demand, new trends in consumerism, the obsolescence of older plants and development of new technology demand a more enlightened approach to the regulatory process. Like electric utilities and, indeed, consumer activists, regulators must adopt more innovative approaches in dealing with the issues of rate-making, demand and construction costs.

Whether the D.C. Public Service Commission is prepared to do that remains to be seen. In the meantime, it has been presented with a controversial alternative to construction of new power generating plants. According to the proposal favored by consumer advocates, conservation will obviate the need for new generating capacity. That has yet to be proved, of course.

Pepco is seeking approval from the Maryland Public Service Commission to build two new generating plants at Dickerson, Md. The D.C. Peoples Counsel, however, opposes the plan, contending that it would be cheaper for the utility to pay consumers to conserve energy.

Under the rubric of conservation, utilities in some parts of the country have paid customers to save energy by giving them rebates on the purchase of energy-efficient appliances or by providing low-interest loans to buy energy-saving equipment.

Those strategies may have been helpful in conserving energy and holding down costs but they can hardly be called a panacea or even a viable alternative for meeting increased demand created by the kind of explosive growth that is occurring in Pepco's service area.

To be sure, Pepco has erred in forecasting demand for electricity in the past. According to published reports, Pepco had expected peak-period demand for electricity to increase about 2 percent annually, but demand actually grew 4 to 5 percent in the past three years, notwithstanding implementation of the utility's consumer conservation programs.

It should be obvious that the demand trend line in Pepco's service area will continue to climb. Don't take Pepco's word. Almost every indicator of economic growth in the local economy points to that. Consider this from the Metropolitan Washington Council of Governments: The Washington region is growing more rapidly than in any period since the 1960s. Reversing a slowdown in population growth in the 1970s, the region is expected to gain at least 332,900 residents in the decade of the 1980s and more than 290,000 in the 1990s.

The forecast for the year 2000 calls for a population of 3.6 million persons. Another 100,000 will be living in the area by 2010, according to COG. Although forecasters don't expect the area's economy to grow at the spectacular rate of the past four years, most agree that the economic boom will continue for several years. Jobs in the inner suburbs, where most of Pepco's customers are, will swell to 1 million by 1990 and at least 1.4 million by 2010. Most jobs will still be in the District.

Further evidence of continued growth -- hence power demand -- can readily be seen in the burgeoning office market. More than 150 million square feet of commercial space have been built since the start of the 1980s. About 25 million square feet of office space currently is available for lease.

In the Washington area and elsewhere, forecasters have seen electricity demand outstripping growth projections in recent years. Although the U.S. Department of Energy's outlook last year called for moderate growth through 1995, electric output in a recent 12-month period rose 3.4 percent in Middle Atlantic states, 4.2 percent in New England and 4.7 percent in the Southeast, all areas of strong economic growth.

In weighing theory against reality, the DCPSC must balance the interests of consumers against the financial health of a regulated business. It can do that first by authorizing practical incentives for consumers, such as discounts on electric bills for conserving energy. At the same time, the PSC should allow Pepco to proceed with a phased construction plan, as needed, using the latest technology in coal gasification and combined-cycle generating power.