Refer to figure 4: An artisanal goat‑yoga studio operates out of a ground‑floor commercial unit in a mixed‑use building. Each yoga class generates profits for the studio, but the presence of goats creates unpleasant odors that drift into the residential unit above. As the number of classes increases, profits rise, but so do the odor‑related costs imposed on the upstairs resident. The figure below shows the marginal costs of additional yoga classes and the marginal external costs imposed on the resident. Society in this case is just the studio owner and the resident above.

Refer to figure 4 above. Select the correct statement.

Question

Refer to figure 4: An artisanal goat‑yoga studio operates out of a ground‑floor commercial unit in a mixed‑use building. Each yoga class generates profits for the studio, but the presence of goats creates unpleasant odors that drift into the residential unit above. As the number of classes increases, profits rise, but so do the odor‑related costs imposed on the upstairs resident. The figure below shows the marginal costs of additional yoga classes and the marginal external costs imposed on the resident. Society in this case is just the studio owner and the resident above.

Refer to figure 4 above. Select the correct statement.

BlackTom AI · Accepted Answer

Coase theorem requires there being low to no transaction costs.

Relevant knowledge points and concepts:
- Externalities occur when a private activity (goat‑yoga classes) imposes costs (odor) on others (the upstairs resident) that are not reflected in market prices.
- The Coase theorem states that if property rights are well‑defined and transaction costs are zero (or negligible), private parties can bargain to an efficient (socially optimal) allocation of resources regardless of the initial assignment of rights.
- Efficiency here means the number of classes where private benefit equals the full social cost (private cost + external cost).

Step‑by‑step reasoning:
1. Identify the two affected parties: the studio owner (benefits from additional classes) and the resident (suffers odor costs). Society = these two actors.
2. Determine the social optimum: add classes until marginal private benefit equals marginal social cost (marginal private cost + marginal external cost). If classes exceed that point, net social welfare falls.
3. Apply Coase: if property rights are clearly specified and bargaining is costless, the studio and resident can negotiate a mutually beneficial arrangement (e.g., fewer classes with compensation, or compensation to the resident to tolerate more classes) that yields the efficient number of classes.
4. The crucial requirement is low transaction costs—without costly negotiation, bargaining may fail and the market will not reach the efficient outcome.

Why the correct answer is correct:
- The option stating low to no transaction costs is precisely one of the key conditions for the Coase theorem to hold. With negligible transaction costs, private negotiation internalizes the externality and achieves efficiency.

Why the other options are incorrect:
- “Uncertain property rights” is wrong: Coase requires well‑defined (not uncertain) property rights to allow bargaining.
- “Large number of small, homogeneous actors” is wrong: Coase outcomes are easier with a small number of parties; many parties raise transaction costs and hinder bargaining.
- “Market will always solve external costs” is wrong: markets solve externalities only under Coasean conditions (zero transaction costs and clear rights); otherwise government or other interventions may be needed.

Conclusion: The correct choice—Coase theorem requires there being low to no transaction costs—matches the provided answer.

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