State the Coase Theorem and the conditions under which private bargaining can internalize externalities.

• A. If property rights are well defined and transaction costs are high, bargaining can be efficient.
• B. If property rights are well defined and transaction costs are very low, bargaining can be efficient.
• C. Only when there are many parties to bargain with.
• D. It always works regardless of transaction costs.

Answer: (B)

The Coase Theorem shows that private bargaining can internalize externalities when two conditions hold: property rights are clearly defined and transaction costs are very low. With well-defined rights, the affected parties know who has the authority to make decisions, and with very low bargaining costs they can strike a deal that makes both sides better off, capturing all the gains from trade and reaching the efficient level of the activity. The outcome is driven by the efficiency of the agreement, not by who initially holds the rights, though who pays whom can affect who benefits in distribution terms. If bargaining is costly or rights are unclear, these conditions break down and private negotiation may fail to reach the efficient outcome. The other statements miss these key conditions: high transaction costs block efficient bargaining; having many parties is not the defining requirement; and it does not always work when transaction costs are not negligible.