Question

The Coase theorem states that

A) patents and copyrights will solve the problem of external costs.
B) taxes will solve the problem of external costs.
C) global warming is hard to solve due to the prisoners' dilemma aspect of the problem.
D) property rights are social arrangements governing ownership, use and disposal of factors of production and goods and services.
E) if property rights are established, and if only a small number of parties are involved, and if transactions costs are low, then private transactions are efficient.

Answer 1

The Coase theorem suggests that when property rights are clearly defined and transaction costs are low, externalities can be efficiently managed by the involved parties. The correct answer is option E).

Step-by-step explanation:

The Coase theorem states that if property rights are established, and if only a small number of parties are involved, and if transactions costs are low, then private transactions are efficient. To clarify, Ronald Coase's theory revolves around the well-defined legal responsibilities regarding property rights. When rights are clear, parties involved can negotiate and resolve issues of externalities in a cost-effective manner, as each will seek the least costly method to prevent harm.

In the cited example, if either the farmer or the railroad has a well-defined legal responsibility, they will take measures to prevent sparks from causing fires. This could be by building a fence or adding a spark-reducing gadget on the locomotive, with the entity holding the property right shouldering the costs.