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Chapter 5: Problem 3

What are transactions costs? When are we likely to see private solutions to the problem of externalities?

Short Answer

Expert verified
Transaction costs are costs incurred during a trade process including costs of finding a trade partner, information costs, bargaining costs, and enforcement costs. Private solutions to externalities are likely when property rights are clearly defined, the number of affected parties is small, and transaction costs are low.

Step by step solution

01

Definition of Transaction Costs

Transaction costs refer to the costs that parties incur in the process of agreeing to and following through on a trade. This includes costs incurred in the process of finding a trade partner, information costs, bargaining costs, and enforcement costs.
02

Understanding Externalities

Externalities refer to the costs or benefits that affect a party who did not choose to incur that cost or benefit. These are typically side effects or consequences of economic transactions that affect third parties and are not reflected in market prices.
03

Conditions for Private Solutions

Private solutions to the problem of externalities are more likely to occur under certain conditions. This includes situations where property rights are clearly defined, the number of affected parties is small, and bargaining/transaction costs are low, effectively allowing individuals to solve the problem through voluntary trade.

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