What is the Coase theorem?

The Coase theorem is an economic concept developed by Ronald Coase, which states that in the presence of well-defined property rights and low transaction costs, individuals can negotiate and reach an efficient outcome regardless of the initial allocation of property rights.

According to the Coase theorem, when there are externalities (spillover effects) in economic activities, such as pollution or noise, the affected parties can negotiate and find a mutually beneficial solution without government intervention. This negotiation process involves the affected parties internalizing the external costs or benefits associated with their actions.

The theorem suggests that if property rights are clearly defined and transaction costs are low, the affected parties can bargain and allocate resources efficiently. In this process, the party causing the externality may compensate the affected party for the harm caused, or the affected party may pay the party causing the externality to reduce or eliminate the harm.

The Coase theorem highlights the importance of property rights and the ability of individuals to negotiate and find solutions to externalities without government intervention. However, it also assumes perfect information, costless bargaining, and no strategic behavior, which may not always hold in real-world situations.