If property rights are clearly defined, can the economy still experience externalities?

• A. No, clearly defined property rights always eliminate all externalities.
• B. Yes, externalities can still occur if transaction costs prevent parties from negotiating efficient outcomes.
• C. No, externalities are only present when property rights are not defined.
• D. Yes, but only positive externalities can exist with clear property rights.

Answer: (B)

Verified step by step guidance

1. Understand the concept of externalities: Externalities occur when a third party is affected by the actions of others, and these effects are not reflected in market prices.
2. Recognize the role of property rights: Clearly defined property rights mean that ownership and usage rights are legally established, which can help internalize externalities by assigning responsibility.
3. Consider the Coase Theorem: According to the Coase Theorem, if property rights are well-defined and transaction costs are zero, parties can negotiate to reach efficient outcomes that eliminate externalities.
4. Analyze the impact of transaction costs: In reality, transaction costs (such as bargaining costs, enforcement costs, or information costs) often exist and can prevent parties from negotiating effectively, allowing externalities to persist even with clear property rights.
5. Conclude that externalities can still occur despite clear property rights if transaction costs hinder efficient negotiation, meaning that property rights alone do not guarantee the elimination of all externalities.