Why might the Coase theorem fail in real-world settings?

• A. High transaction costs, many affected parties, or poorly defined property rights.
• B. All externalities are negative.
• C. Private bargaining always succeeds.
• D. There is no possible solution.

Answer: (B)

The key idea is that private bargaining can fix externalities only when it’s cheap and easy to bargain and enforce agreements. In the real world, those conditions often fail. If transaction costs are high, negotiating and enforcing an agreement becomes expensive. When many people are affected, coordinating a deal with everyone grows complex and costly, leading to holdout problems and stalled negotiations. If property rights are poorly defined or hard to enforce, it’s unclear who should be compensated or who bears the costs, making bargaining ineffective. Because of these frictions, private agreements may not occur or may be inefficient, so the Coase theorem doesn’t reliably hold in practice.

It’s not about all externalities being negative. The theorem can apply to either type of externality under ideal conditions; its failure stems from real-world bargaining obstacles, not the nature of the externalities themselves.