According to the Coase theorem, externalities
a.must usually be internalized by taxation or subsidy.
b.can be internalized by the market under certain conditions.
c.result when firms fail to maximize profits.
d.cannot be internalized if property rights are assigned.
e.are not relevant to the issue of market failure.
The Correct Answer and Explanation is :
The correct answer is:
b. can be internalized by the market under certain conditions.
Explanation:
The Coase Theorem, developed by economist Ronald Coase in 1960, argues that externalities—unintended side effects of economic activities, such as pollution—can be efficiently resolved through private bargaining, provided certain conditions are met. The key idea is that if property rights are well-defined and transaction costs are low, parties involved in the externality can negotiate with each other to arrive at an efficient outcome without the need for government intervention (e.g., taxes or subsidies).
For example, if a factory emits pollution that affects nearby residents, and property rights are clearly assigned (e.g., the residents have the right to clean air), the residents can negotiate with the factory to reduce the pollution, or the factory might pay the residents for the right to pollute. This negotiation process can lead to an outcome where resources are allocated efficiently, even in the presence of an externality.
However, the Coase Theorem relies on several assumptions:
- Well-defined property rights: It must be clear who owns what resources and who has the right to control them.
- Low transaction costs: The costs associated with bargaining and enforcing agreements should be low. If transaction costs are high (e.g., if there are many parties involved or if communication is difficult), it becomes less likely that private negotiations will lead to an efficient outcome.
- No significant wealth effects: The parties involved should not face large income disparities that would prevent an efficient bargain.
If these conditions are not met, government intervention may still be necessary to address the externality. While the Coase Theorem offers an important insight into the potential for private solutions, it doesn’t suggest that all externalities can always be internalized without government action.
Now, I will generate an image to visually represent this concept.
Here is an image representing the Coase Theorem in economics, showing a negotiation between factory owners and residents over pollution. It visually captures the concept of property rights and the potential for resolving externalities through private bargaining. Let me know if you’d like further explanation or another image!
