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CA Foundation · Business Economics · Public Finance

According to the Coase theorem, private parties can resolve an externality efficiently through bargaining without government intervention, provided that:

The Coase theorem holds when property rights are clearly defined and transaction costs are low or negligible. Under these conditions the affected parties can bargain to reach an efficient outcome whoever initially holds the right, so no government tax or regulation is needed to correct the externality.

  1. AThe externality is positive and the government gives a subsidy
  2. BProperty rights are clearly defined and transaction costs are low or negligibleCorrect
  3. CThe number of affected parties is very large and transaction costs are high
  4. DThe polluting firm is always given the right to pollute by law

Explanation

The Coase theorem needs well-defined enforceable property rights and low transaction costs so the parties can bargain. With many affected parties and high costs, bargaining fails, so option 3 is the opposite of the condition. The theorem holds regardless of who is given the initial right, so option 4 is not required.

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