Which of the following is a necessary condition for the Coase Theorem to hold in resolving externalities?

• A. Property rights must be clearly defined and transaction costs must be negligible.
• B. Firms must operate under perfect competition with identical cost structures.
• C. The government must set a price ceiling on the good causing the externality.
• D. Externalities must be positive rather than negative.

Answer: (A)

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) 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 (costs of bargaining, enforcing agreements, etc.) must be negligible or very low.
3. Recognize that other options such as perfect competition, government price ceilings, or the sign of the externality (positive or negative) are not necessary conditions for the Coase Theorem to apply.
4. Focus on the importance of clearly defined property rights because without them, parties cannot negotiate effectively, and without low transaction costs, bargaining may be too costly to reach an efficient outcome.
5. Conclude that the necessary condition for the Coase Theorem to hold is that property rights must be clearly defined and transaction costs must be negligible.