In which of the following cases is the Coase Theorem most likely to solve the externality?

• A. When property rights are ambiguous and enforcement is difficult
• B. When property rights are clearly defined and transaction costs are low
• C. When there are a large number of parties involved and negotiation is costly
• D. When government intervention sets a price ceiling

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 negligible, private parties can negotiate to resolve externalities efficiently without government intervention.
2. Identify the key conditions for the Coase Theorem to hold: (1) Clearly defined property rights, and (2) Low or zero transaction costs for negotiation and enforcement.
3. Analyze each option in terms of these conditions: For example, ambiguous property rights or high transaction costs prevent effective negotiation, making the theorem less applicable.
4. Recognize that when there are many parties or costly negotiations, transaction costs rise, reducing the likelihood that private bargaining will solve the externality.
5. Conclude that the scenario where property rights are clearly defined and transaction costs are low best fits the conditions under which the Coase Theorem can solve the externality.