What conditions are needed for Coase bargaining to efficiently solve an externality?

• A. Low transaction costs, well-defined property rights, and the ability to bargain.
• B. High transaction costs make bargaining infeasible.
• C. Property rights must be ignored.
• D. Bargaining is never efficient.

Answer: (A)

The idea being tested is that private bargaining can solve externalities when the conditions for bargaining are favorable. Under this view, the efficient outcome emerges when transaction costs are low enough that parties can negotiate without prohibitive expense, and property rights are clearly defined so there is a recognizable entitlement to trade. With such rights, the party who bears or causes the externality can be compensated or required to adjust, and both sides can bargain to the point where the marginal social benefit of the activity equals the marginal social cost. In practice, this means you can reach the efficient level of activity by trading rights or payments, regardless of who initially holds the rights, as long as bargaining is feasible and costs are minimal. If transaction costs are high, bargaining becomes impractical and the private solution fails to be efficient. If property rights aren’t clearly defined, there’s no straightforward entitlement to trade, so negotiations stall or become paralyzed by dispute. Saying bargaining is never efficient ignores the key insight that efficiency can be achieved privately when these conditions are met.