Final answer:
To address the externality problem when Coase theorem's conditions are not met, the law can offer solutions by defining property rights and enacting regulations. This helps establish clear responsibilities and balance economic activity with environmental quality.
Step-by-step explanation:
When the conditions of the Coase theorem are not met, addressing the externality problem can be approached through law. The Coase theorem suggests that if property rights are well-defined and transaction costs are minimal, externalities can be negotiated away by the parties involved; however, when conditions do not allow for such negotiation, legal intervention may provide a solution. This involves the establishment or reinforcement of property rights, and potentially, government regulation. For example, the law could dictate specific responsibilities, like requiring the railroad in Coase's illustration to install a spark-reducing gadget, or imposing a governmental limit on the amount of pollution a company can emit.
Law can be a powerful tool for managing externalities by setting clear boundaries and obligations, which can lead to a balance between economic activity and environmental protection. Policies for environmental protection have traditionally focused on governmental limits on emissions. Although this approach has seen some success, the economics of pollution implies a need for more nuanced, market-oriented policies to reduce pollution more efficiently and at lower costs.