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IAI Actuarial Core Principles · Business Economics · Relationship between the government and the individual firm

Under the Coase theorem, which condition is essential for private bargaining between a polluting factory and affected residents to reach an efficient outcome without government intervention?

The Coase theorem requires well-defined property rights and low transaction costs. Then the parties bargain to an efficient level of pollution whichever side holds the rights. With many victims or unclear rights, bargaining fails and government action such as taxes or regulation may be needed.

  1. AThe government must set a uniform emissions tax
  2. BProperty rights are well defined and transaction costs are lowCorrect
  3. CThe factory must be a monopolist
  4. DThe residents must outnumber the factory owners significantly
  5. Pollution must be a pure public good with no identifiable victims

Explanation

Coase showed that, with clearly assigned property rights and negligible transaction costs, parties can bargain to the efficient outcome regardless of who initially holds the rights. Large numbers of victims raise transaction costs and usually defeat this solution, so that option is wrong.

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