Private solutions to externalities tend to be most effective when:

Private solutions to externalities tend to be most effective when transaction costs are low. This is founded on the Coase theorem, which states that if property rights are clearly defined and transaction costs are minimal, parties can negotiate solutions to externalities without the need for government intervention. When transaction costs are low, individuals can easily communicate and bargain over the allocation of resources and the responsibilities associated with externalities.

For example, if two neighboring farmers are causing externalities affecting each other, and they can negotiate freely without incurring significant costs (such as legal fees or extensive time delays), they are likely to reach an agreement that improves their situation. This leads to more efficient outcomes, because they can adapt solutions based on their particular circumstances and preferences.

Conversely, when transaction costs are high, parties may be discouraged from negotiating, leading to inefficient outcomes and potential losses from the externalities not being addressed. Similarly, if there is resource ownership dispute or reliance on government regulations, these factors complicate the negotiation process, making it harder for parties to arrive at mutually beneficial agreements. Thus, low transaction costs create the ideal environment for private solutions to externalities to flourish effectively.