Security markets are efficient except for when which of the following exists?

• A. Parties can bargain without cost
• B. Transaction costs are high
• C. Property rights are clearly defined
• D. There are no externalities

Answer: (B)

Verified step by step guidance

1. Understand the concept of market efficiency: In microeconomics, an efficient market is one where resources are allocated in a way that maximizes total surplus, meaning no one can be made better off without making someone else worse off.
2. Recognize the role of transaction costs: Transaction costs are the costs associated with making an economic exchange, such as bargaining, enforcing contracts, or searching for information. High transaction costs can prevent mutually beneficial trades from occurring.
3. Recall the Coase Theorem: This theorem states that if property rights are clearly defined and parties can bargain without cost, then the allocation of resources will be efficient regardless of who holds the rights.
4. Identify the condition that disrupts efficiency: When transaction costs are high, bargaining becomes costly or impossible, preventing efficient trades and causing market inefficiency.
5. Conclude that security markets are efficient except when transaction costs are high, because high transaction costs hinder the ability of parties to negotiate and reach efficient outcomes.