Texas A&M University (TAMU) ECON202 Practice Exam 2

The Coase theorem suggests that when property rights are well-defined and transaction costs are low, parties can negotiate solutions to externality problems amongst themselves without the need for government intervention. This implies that it is not always necessary for the government to step in to regulate or solve issues arising from externalities, such as pollution or resource depletion. Instead, individuals or firms affected by externalities can reach mutually beneficial agreements that lead to efficient outcomes.

When transaction costs are minimal, negotiations can lead to solutions that align with the preferences and interests of those involved, allowing them to address the externality directly. This perspective highlights the theorem's emphasis on private bargaining as an effective means of allocating resources in the presence of externalities, thus negating the need for mandatory government intervention in all cases.

By understanding the conditions under which the Coase theorem holds—such as clearly defined property rights and negligible transaction costs—it becomes evident that there are scenarios where the market will self-correct without government action.