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CA Foundation · Business Economics · Public Finance

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

The Coase theorem holds that parties can bargain to an efficient outcome by themselves if property rights are clearly defined and transaction costs are low or negligible. In that case the initial allocation of rights affects who pays, not efficiency.

  1. AProperty rights are well defined and transaction costs are low or negligibleCorrect
  2. BThe government fixes the price of the polluting good
  3. CThe externality is positive rather than negative
  4. DOnly one party is affected by the externality and it is a public good

Explanation

The Coase theorem says that if property rights are clearly assigned and bargaining costs are very low, affected parties can negotiate to reach an efficient outcome whoever holds the rights. The nature of the externality (positive or negative) is not the condition. Price fixing by government is not required.

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