Income transfers,entrepreneurial effort,and the Coase theorem: The case for efficiency reconsidered

The Coase theorem asserts that private bargaining can overcome the difficulties posed by an externality situation and lead to a first-best allocative solution. For such idealized efficiency to be achieved, however, it is generally recognized that certain very special conditions must be met—including the assumption of zero transaction costs. In opposition to this view, the paper argues that the special simplifying conditions usually specified in the literature are not sufficient. Unless stringent supplementary conditions are introduced, private bargaining will not bring about a first-best solution. Indeed, if the standard assumptions are met but the supplementary conditions of the paper are not, government intervention in the externality case can be expected to produce a solution that is Pareto superior to the one generated by private bargaining.