1)What is the Coase Theorem? Explain under what circumstances private negotiation will fail to produce a solution. Give an example to illustrate the Coase Theorem.

The Coase Theorem is an economic and a legal theory formulated by Ronald Coase and states that, with the presence of complete competitive markets without costs of transactions and efficiently set outputs and inputs, optimal decisions get reached. The theory states that, regardless of the situation, disputing parties can reach optimally-economic solutions with the right conditions.

Private negotiations may not produce solutions in inefficiently competitive market conditions. According to the Coase theory, an optimal solution can be realized with zero negotiation costs, unavailable market power differences, and efficient markets. Unavailability of either of these conditions would lead to a failed attempt to get a private negotiation solution.

An example, assuming there is a privately owned park with a river around it. With individuals visiting the park and walking down the river to enjoy the view, they litter, and plastic bottles are found in the vicinity. Then the society benefiting from the river is faced with the negative externality of pollution and files for a lawsuit. These laws suits could go back and forth but can get resolved with the Coase theorem. Given that the river does not belong to anyone, the property rights can get reviewed, and without any transactional costs, the community and the private park owner can bargain to reach an economically-optimal solution.