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

The Coase Theorem postulates that if property rights are well-defined and transaction costs are negligible, private negotiations between parties will lead to an efficient allocation of resources, regardless of the initial distribution of rights. This means that when individuals can negotiate freely without significant costs or barriers, they will arrive at outcomes that maximize total welfare and utilize resources most efficiently.

The theorem emphasizes the importance of negotiation in resolving externalities—situations where a party's actions affect others. By allowing involved parties to bargain and reach agreements, they can internalize the external costs or benefits and find a mutually beneficial solution. This principle showcases the power of market forces and private negotiation in achieving efficiency, supporting the idea that minimal or no government intervention is needed in such scenarios.

In contrast, the other options do not accurately reflect the core concept of the Coase Theorem. For instance, suggesting that negotiation leads to conflicts overlooks the theorem's assertion that efficient outcomes can be reached through dialogue. The notion that it requires government mediation contradicts the theorem's emphasis on private negotiations. Lastly, stating that it is less effective than regulation diminishes the theorem's argument about the effectiveness of private bargaining in achieving resource allocation efficiency when conditions are favorable.