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IAI Actuarial Core Principles · Business Economics · Government intervention in a market

Under a Coase-type approach to a pollution externality, which condition is essential for private bargaining alone to deliver an efficient outcome?

Clearly defined property rights and low transaction costs are required. With these, the affected parties can negotiate to the efficient level of the externality whichever side holds the rights. Many parties or high costs of bargaining prevent this, making government intervention necessary.

  1. AProperty rights are well defined and transaction costs are lowCorrect
  2. BThe government must set a Pigouvian tax
  3. CThe number of affected parties must be very large
  4. DThe polluter must be a monopolist
  5. The externality must be positive rather than negative

Explanation

Coase argued that if property rights are clearly assigned and bargaining is costless, the parties negotiate to the efficient outcome irrespective of who holds the rights. With many affected parties, transaction and free-rider costs rise and bargaining fails, so a large number is the opposite of what is needed.

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