Coase Theorem Practice Quiz | AP Microeconomics Review Questions

📚 Topic Summary

The Coase Theorem, named after economist Ronald Coase, states that if property rights are well-defined and transaction costs are low, parties will bargain to an efficient outcome regardless of the initial allocation of property rights. This means resources will be used in their most valuable way, regardless of who initially owns them. It's a fundamental concept in understanding how externalities can be resolved through negotiation rather than government intervention.

In simpler terms, imagine a factory polluting a river used by fishermen. The Coase Theorem suggests that, regardless of whether the factory has the right to pollute or the fishermen have the right to clean water, the parties can negotiate a solution where the overall economic outcome is maximized. This might involve the factory compensating the fishermen, or vice versa, to reach an agreement that benefits both parties more than the status quo. The key is low transaction costs and clearly defined rights.

🧠 Part A: Vocabulary

Match the terms with their definitions:

📝 Part B: Fill in the Blanks

Complete the following paragraph:

The Coase Theorem suggests that with clearly defined ________ and low ________, private parties can resolve ________ problems efficiently. This often involves ________ to reach a mutually beneficial agreement, leading to an ________ outcome regardless of the initial allocation of rights.

💡 Part C: Critical Thinking

Consider a scenario where a homeowner enjoys playing loud music, disturbing their neighbor. How could the Coase Theorem be applied to resolve this conflict? Explain the possible outcomes and the conditions necessary for the theorem to hold.