Under what conditions does the Coase theorem predict the market will efficiently resolve externalities?

• A. Low transaction costs, clearly defined property rights, and a small number of bargaining parties.
• B. High transaction costs, many parties.
• C. No property rights.
• D. Government intervention is always required.

Answer: (A)

Private bargaining can efficiently resolve externalities when negotiation is feasible and rights are clear. The Coase theorem shows that if transaction costs are low, people can trade rights and make deals that internalize the external cost or benefit, and the outcome is efficient regardless of who initially holds the rights. Clearly defined property rights give parties a specific target for negotiation and a way to enforce any agreement, removing ambiguity about who pays or who benefits. A small number of bargaining parties keeps the transaction and coordination costs manageable, reducing the chance that negotiations break down or become prohibitively expensive. If any of these conditions fail—high transaction costs, vague or missing property rights, or many involved parties—private bargaining is unlikely to produce an efficient outcome, and some form of government intervention or market regulation may be needed.