Final answer:
The Coase theorem states that if transaction costs are low, private bargaining can lead to an efficient solution to externalities, given well-defined property rights, without necessarily requiring government intervention. It emphasizes the potential for private negotiation to solve externality problems under the right circumstances.
Step-by-step explanation:
The Coase theorem posits that if transaction costs are low, private bargaining will result in an efficient solution to the problem of externalities. The theorem, named after its originator, Nobel laureate Ronald Coase, addresses situations where external effects of economic transactions affect third parties who are not involved in the transaction.
The classic example Coase provided was of a railroad emitting sparks and causing damage to a farmer's field. The question posed is whose responsibility it is to prevent this damage. Coase suggested that, given well-defined property rights and low transaction costs, the parties involved could negotiate to address the issues of external costs and benefits without requiring government intervention.
It is important to note that the Coase theorem assumes that parties can negotiate without high transaction costs for an efficient outcome. It does not assert that free-market equilibrium is the best solution for all externality problems, nor does it argue that government intervention is always necessary or that assigning property rights is the only role for government in the market economy. Rather, it presents an option for private negotiation to address externalities, given the right conditions.