The Coase Theorem

The Coase Theorem suggests that when property rights are clearly defined and transaction costs are low, individuals and businesses can negotiate solutions to externalities—situations where one party's activities affect another—without government intervention. For example, if a factory pollutes a river, the factory and nearby residents can negotiate compensation or changes to reduce the pollution. The theorem implies that efficient outcomes can be reached as long as parties can talk and arrange agreements, regardless of who holds the rights initially. However, in reality, high transaction costs or undefined rights can hinder this process.