Which of the following statements about vertical integration is true in the context of private solutions to externalities and the Coase Theorem?

• A. Vertical integration always eliminates all externalities regardless of transaction costs or property rights.
• B. Vertical integration can help internalize externalities by merging firms whose actions affect each other, potentially reducing transaction costs.
• C. The Coase Theorem states that vertical integration is unnecessary for resolving externalities.
• D. Vertical integration increases externalities by separating related firms.

Answer: (B)

Verified step by step guidance

1. Step 1: Understand the concept of vertical integration. Vertical integration occurs when a firm expands its operations into different stages of production or distribution within the same industry, often merging with firms that are suppliers or buyers.
2. Step 2: Recall the Coase Theorem, which states that if property rights are well-defined and transaction costs are negligible, private parties can negotiate to resolve externalities efficiently without government intervention.
3. Step 3: Analyze how vertical integration relates to externalities and the Coase Theorem. Vertical integration can internalize externalities by bringing related firms under common ownership, which can reduce or eliminate the need for negotiation between separate entities and lower transaction costs.
4. Step 4: Evaluate the statements given: Vertical integration does not always eliminate all externalities because transaction costs and property rights issues may still exist; the Coase Theorem does not claim vertical integration is unnecessary but rather focuses on negotiation under low transaction costs; vertical integration typically reduces, not increases, externalities by aligning incentives.
5. Step 5: Conclude that the true statement is that vertical integration can help internalize externalities by merging firms whose actions affect each other, potentially reducing transaction costs, aligning with the principles of the Coase Theorem.