Which of the following is a necessary condition for the Coase Theorem to hold in resolving externalities?

• A. Firms must operate under perfect competition with identical cost structures.
• B. Property rights must be clearly defined and transaction costs must be negligible.
• C. The government must set a price ceiling on the good causing the externality.
• D. Externalities must be positive rather than negative.

Answer: (B)

Verified step by step guidance

1. Understand the Coase Theorem: It states that if property rights are well-defined and transaction costs are zero or negligible, private parties can negotiate to resolve externalities efficiently without government intervention.
2. Identify the key conditions for the Coase Theorem to hold: (1) Property rights must be clearly defined so that parties know who has the legal authority over the resource causing the externality, and (2) Transaction costs (costs of bargaining, enforcing agreements, etc.) must be negligible to allow efficient negotiation.
3. Analyze the options given: The condition about firms operating under perfect competition or identical cost structures is not necessary for the Coase Theorem; it focuses on property rights and transaction costs.
4. Recognize that government intervention like price ceilings is not required under the Coase Theorem because private negotiation should lead to efficient outcomes if conditions hold.
5. Note that the theorem applies to both positive and negative externalities, so the externality being positive is not a necessary condition.