Question

7. Explain why accepting all economic projects yielding a positive Net Present Value could lead to an excessive amount of government regulation

Answer 1

If economic projects continue to produce positive net present value, then it means that only private cost are considered and marginal external costs are avoided by the firms. It makes firms earning profit, reflected by a positive net present value (NPV). But, it also means that negative externality to the society and scope of market failure. To resolve the problem of market failure, the government comes out with the regulations. It can be a new tax to achieve socially optimal equilibrium, regulations related to the use of technology and or cap and trade system. It means that new regulations come out in the economy. Hence, it is said that economic projects delivering positive NPVs are going to bring excessive government regulations.