Which of the following conditions must be true for the Coase Theorem to hold and allow private parties to solve externalities efficiently?

• A. All parties must have identical preferences regarding the externality.
• B. The government must set a price ceiling on the good causing the externality.
• C. Externalities must only affect producers, not consumers.
• D. Property rights must be clearly defined and transaction costs must be negligible.

Answer: (D)

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 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 (such as bargaining costs, enforcement costs, or information costs) must be very low or zero to allow efficient negotiation.
3. Recognize that identical preferences among parties are not required; parties can have different valuations and still reach an efficient outcome through bargaining.
4. Note that the government setting price ceilings or externalities affecting only producers are not conditions required by the Coase Theorem; these are unrelated or incorrect assumptions.
5. Conclude that the essential conditions are clear property rights and negligible transaction costs, enabling private negotiation to internalize the externality and achieve an efficient allocation.