Coase Theorem

When faced with an externality, the same efficient outcome can be reached without any government intervention as long as the following assumptions hold:

1. Property rights must be clearly defined
2. There must be little to no transactions costs
3. (Following 2.) There must be few affected parties (or else the transactions costs of organizing them gets to be too great).
4. There must be no wealth effects.

The efficient solution will be the same, regardless of who gets the initial property rights.

The Coase Theorem shows that the essence of the market is not price, but property rights. As long as there are property rights, people will naturally "negotiate" a reasonable price.

The Coase theorem implies that the market will solve externalities all by itself unless:

1. property rights are incomplete (for example, no one owns the air) or
2. negotiating is costly

Reference

The Problem of Social Cost^[1] by Ronald Coase