Questions: The parties involved in an externality have an incentive to reach an efficient solution because A. government regulations compel private parties. B. it is morally the right thing to do. C. the party that causes negative externality does not have any legal right to do so. D. both parties become better off when an efficient solution is reached.

The answer is D: both parties become better off when an efficient solution is reached.

Explanation for each option:

A. Government regulations compel private parties.
This option is incorrect because while government regulations can influence behavior, the question is about the incentive for parties to reach an efficient solution on their own, without external compulsion.

B. It is morally the right thing to do.
This option is incorrect because moral considerations, while important, are not the primary economic incentive for parties to resolve externalities. The question focuses on economic incentives rather than ethical motivations.

C. The party that causes negative externality does not have any legal right to do so.
This option is incorrect because the legal rights of the parties involved are not the primary focus of the incentive to reach an efficient solution. The incentive is more about mutual benefit rather than legal rights.

D. Both parties become better off when an efficient solution is reached.
This option is correct because, according to economic theory, when parties involved in an externality negotiate and reach an efficient solution, they can both benefit. This is often explained by the Coase Theorem, which suggests that if transaction costs are low and property rights are well-defined, parties can negotiate to correct externalities and improve overall welfare.