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- The free rider problem is an economic concept of market failure that occurs when people enjoy a shared resource without having to contribute to it.
- Private companies usually can't profit from providing public goods, so they're usually supplied by the government and paid for with tax dollars.
- Solutions to the free rider problems vary depending on how you expect consumers to behave.
- Read more stories from Personal Finance Insider.
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There are things in life that you don't have to pay for. But that doesn't necessarily mean they're free, it just means the cost doesn't fall on you. If you can consume something — be it music on the street or a communal park — without having to pay for it, that makes you a free rider.
When too many free riders consume a shared resource, it becomes difficult to maintain that resource, which is known as the free rider problem.
What is the free rider problem?
In economics, goods are defined by two characteristics: excludability and rivalry. Excludability means that once the good is provided, you can exclude people from using it even if they didn't pay to use it. Rivalry means that one person's consumption of a good means that another person cannot consume that good, or their own use is detracted.
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The free rider problem is a market failure that occurs when a good is non-rivalrous and non-excludable, also known as a public good. Once a public good is established, "benefits are all privatized, cost is all socialized," says Tarun Kushwaha, a marketing professor at George Mason University's School of Business. In other words, people can consume the good without having to pay their fair share in its upkeep.
Characteristic | Excludable | Non-excludable |
Rivalrous | Private goods
| Common goods
|
Non-rivalrous | Club goods
| Public goods
|
Because of the free rider problem, the costs of maintaining a public good heavily outweigh any profits that they might make, which discourages private companies from producing them through the free market. It usually falls upon the government to provide these goods, such as national defense or transportation infrastructure. These public goods can avoid the free rider problem because technically you are paying the government to provide these services — through taxes.
However, in small-scale scenarios where a community is trying to provide a public good, it can be difficult to overcome free riders.
How to solve the free rider problem
The free rider problem is a common discussion for a reason: it's difficult to find a solution that keeps something non-excludable. "We have been trying to design systems forever to solve this problem, but it's not easy," Kushwaha says.
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Interestingly, solutions vary based on how you expect consumers to behave or, in other words, if you think people are selfish or altruistic.
Privatize public goods: In an economic view where people are inherently self-interested, you can't count on consumers contributing to a public good. If you believe this, Kushwaha says, "you can never have a completely free public good that is sustainable in the future forever. It eventually will fail," he says.
One solution would be to privatize the public good and make it excludable or get rid of it entirely. For example, certain gated parks are only accessible to residents in the surrounding area. In our sidewalk situation, a homeowners association might just scrap the project and implement requirements for homeowners to maintain the section of the sidewalk in front of their house.
Appeal to altruism: In most economic models, we assume that consumers are rational, which means that they will make choices based on what's most beneficial to them. Though this assumption makes economic theory easier on larger scales, this isn't necessarily true in practice. People are not always rational in the way that economics assumes they are, which offers a way to combat the free rider problem.
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Instead of taking away the choice of whether or not to contribute to a public good, this approach encourages people to contribute because it's the right thing to do. In our sidewalk example, this might mean contributing to the sidewalk fund for no reason other than that you feel obligated to as a member of the community.
Incentivise contributions: Offering an incentive to contribute to a public good lies somewhere between this spectrum of human behavior. An incentive gives potential free riders a reason to contribute even if they could enjoy a public good without it.
These incentives don't necessarily need to have monetary value. Instead, they can be symbolic. Going back to our sidewalk example again, incentives might be offered in the form of your name listed on a plaque if you donate a certain amount. "You can essentially signal to your society, your peers, that, 'Hey, look, I am contributing to this good cause," Kushwaha says.
Associate Editor at Personal Finance Insider
Paul Kim is an associate editor at Personal Finance Insider. He edits and writes about credit scores, debt, and identity theft.When he's not writing, Paul loves cooking and eating. He hates cilantro.
As an enthusiast and expert in the field of economics and finance, my knowledge extends to various concepts related to market dynamics, economic theories, and financial strategies. My credentials include a deep understanding of the free rider problem, an economic concept that plays a pivotal role in market failures.
The article discusses the free rider problem, which arises when individuals benefit from a shared resource without contributing to its maintenance. The core economic principle involved in this scenario is the distinction between excludability and rivalry in goods. Excludability refers to the ability to prevent individuals from using a good if they haven't paid for it, while rivalry indicates that one person's consumption affects the ability of others to consume the same good.
Goods are categorized based on these characteristics into private goods (both excludable and rivalrous), common goods (rivalrous but non-excludable), club goods (excludable but non-rivalrous), and public goods (non-excludable and non-rivalrous). The free rider problem particularly affects public goods, as individuals can enjoy them without paying their fair share, leading to challenges in sustaining these resources through private market mechanisms.
The article suggests that due to the free rider problem, private companies often find it unprofitable to provide public goods, and the responsibility often falls on the government, funded by tax dollars, to ensure their provision. Notable examples of public goods include national defense and transportation infrastructure.
The piece explores potential solutions to the free rider problem, acknowledging that overcoming it is challenging. One approach involves privatizing public goods to make them excludable or eliminating them entirely. This aligns with the assumption that people are inherently self-interested. Another strategy focuses on appealing to altruism, encouraging individuals to contribute to public goods because it is considered the right thing to do.
Furthermore, the article suggests incentivizing contributions as a middle ground, offering rewards or recognition for those who contribute to public goods. These incentives, whether monetary or symbolic, aim to motivate individuals to participate in maintaining shared resources.
In summary, my expertise allows me to delve into the intricate details of economic concepts such as the free rider problem, goods classification, and potential solutions to market failures, as discussed in the provided article.
