Free riding

What Is Free Riding?

Free riding is an economic concept describing a situation where individuals or entities benefit from a resource, good, or service without contributing to its cost. This phenomenon is a common example of market failure, particularly prevalent with public goods, which are characterized by being non-excludable and non-rivalrous⁶². Non-excludable means it is impractical or impossible to prevent individuals from using the good even if they don't pay for it, while non-rivalrous means one person's consumption does not reduce its availability for others⁶⁰, ⁶¹. When free riding occurs, those who pay for the good may reduce their contributions, leading to the under-provision or non-provision of valuable collective resources.

History and Origin

The concept of free riding has roots in philosophical discussions on collective action, but it was formally articulated in modern economics in the mid-20th century⁵⁹. The American economist Paul Samuelson is widely credited with developing the theory of public goods and formally defining the free-rider problem in his 1954 paper, "The Pure Theory of Public Expenditure"⁵⁵, ⁵⁶, ⁵⁷, ⁵⁸. Samuelson mathematically defined "collective consumption" goods as those where every consumer enjoys the total output, and one person's consumption does not subtract from another's⁵³, ⁵⁴. His work highlighted that rational, utility-maximizing individuals would not reveal their true preferences for a public good, as they could benefit without contributing, thus acting as free riders⁵².

Following Samuelson's foundational work, Mancur Olson's 1965 book, The Logic of Collective Action: Public Goods and the Theory of Groups, provided the first book-length study of the problem, bringing the notion of free riding into wider economic discourse and establishing it as a standard behavior in certain circumstances⁵⁰, ⁵¹. Olson, relying on an instrumental conception of rationality, argued that individuals have little incentive to contribute to a public good if they will benefit from it whether or not they contribute⁴⁹.

Key Takeaways

• Free riding occurs when individuals consume a good or service without paying for it, relying on others to bear the cost⁴⁸.
• It is particularly common with public goods due to their non-excludable and non-rivalrous nature⁴⁷.
• The free-rider problem can lead to the under-provision or non-provision of beneficial collective resources, representing a market failure⁴⁶.
• Governments often address free riding through mechanisms like taxation and regulation to ensure contributions and provision of public goods⁴⁴, ⁴⁵.
• The problem extends beyond traditional public goods to areas like environmental protection, international agreements, and digital markets⁴¹, ⁴², ⁴³.

Formula and Calculation

The free-rider problem does not involve a specific quantitative formula in the way a financial metric might. Instead, it is understood through economic principles, particularly concerning the marginal benefit and marginal cost of a public good.

For a pure public good, the socially efficient condition for its provision is known as the Samuelson rule. This rule states that the marginal cost of providing the public good should equal the sum of the marginal rates of substitution (MRS) for all individuals who benefit from it³⁸, ³⁹, ⁴⁰. The MRS represents the amount of a private good an individual is willing to give up to obtain one more unit of the public good.

In a scenario with two individuals, A and B, and a public good, G, the Samuelson rule can be expressed as:

Where:

• (MRS_{G,A}) = Marginal Rate of Substitution of public good G for individual A
• (MRS_{G,B}) = Marginal Rate of Substitution of public good G for individual B
• (MC_G) = Marginal Cost of providing public good G

The free-rider problem arises because, in a voluntary contribution system, individuals have an incentive to under-report their true MRS, hoping others will contribute, and they can still enjoy the benefits. This leads to a situation where the sum of private contributions falls short of the optimal social contribution, resulting in under-provision³⁶, ³⁷.

Interpreting the Free Rider

Interpreting the free-rider problem involves understanding how individual rational self-interest can conflict with collective well-being. When individuals choose to free ride, they make a rational choice to maximize their own utility by benefiting from a good or service without incurring the cost. This behavior, while rational for the individual, can lead to a suboptimal outcome for the collective, as the good may be under-provided or not provided at all³⁴, ³⁵.

The presence of free riders is a signal that market mechanisms alone are insufficient to provide certain goods and services efficiently³³. It indicates a divergence between private incentives and social welfare, highlighting the limitations of unregulated markets in allocating resources for collective benefits³¹, ³². The severity of the free-rider problem often increases with the number of potential beneficiaries, as individual contributions become less significant in larger groups³⁰. Understanding free riding is crucial for policymakers and economists when considering the role of government or other collective mechanisms in addressing market failures and ensuring the provision of essential public services.

Hypothetical Example

Consider a neighborhood of 100 homes that would benefit from a new public park. The estimated cost to build and maintain the park for a year is $10,000. If everyone contributed equally, each household would pay $100. The park would provide significant benefits, such as recreational space, increased property values, and a sense of community.

However, the park is a public good: it is non-excludable (once built, it's difficult to prevent anyone in the neighborhood from using it) and non-rivalrous (one person using the park doesn't diminish another's ability to use it).

Sarah, a resident, might think: "If I contribute $100, and everyone else does, we'll have a great park. But if I don't contribute, and everyone else does, I can still use the park for free. If no one else contributes, my $100 won't be enough to build the park anyway, so why bother?"

If enough residents, acting on this individual rational choice, decide to free ride, the total contributions might fall significantly short of the $10,000 needed. For instance, if only 30 households contribute, collecting only $3,000, the park might not be built at all, or it might be a much smaller, less beneficial version. This collective inaction, driven by individual incentives to free ride, results in a failure to provide a public good that would benefit the entire community. This illustrates how individual incentives can lead to a suboptimal social outcome.

Practical Applications

The free-rider problem manifests in numerous real-world scenarios across economics, finance, and public policy:

• Environmental Protection: Efforts to combat climate change, reduce pollution, or preserve natural resources face a significant free-rider problem. Countries or corporations may benefit from global emissions reductions achieved by others without undertaking costly mitigation efforts themselves²⁷, ²⁸, ²⁹. For example, the voluntary nature of international climate agreements has been criticized for enabling this "free-riding syndrome"²⁶.
• Public Broadcasting: Public radio and television stations often rely on voluntary donations. Listeners and viewers can enjoy the content without contributing, leading to funding challenges for these non-excludable services²⁴, ²⁵.
• Research and Development (R&D): In industries where research findings can easily be copied or adapted, companies may free ride on the R&D efforts of competitors rather than investing heavily themselves. This can lead to under-investment in innovation²³.
• Labor Unions: In a partly unionized workplace, non-union members can benefit from improved working conditions or pay raises negotiated by the union without paying union dues, thus free riding on the union's efforts²².
• Digital Content: The digital economy presents new avenues for free riding. Individuals may pirate digital content, such as music, movies, or software, without paying creators, benefiting from the content without contributing to its production cost²¹. Furthermore, concerns exist about "forced free riding" where dominant digital platforms might leverage data from third-party sellers to introduce their own competing products, raising antitrust concerns¹⁹, ²⁰. One example is how manufacturers selling through brick-and-mortar retailers must consider that internet retailers can free ride off of their promotional efforts, leading manufacturers to limit online distribution or control pricing¹⁸.

Limitations and Criticisms

While the free-rider problem is a well-established concept in economic theory, it faces certain limitations and criticisms:

• Assumption of Pure Rationality: The core of the free-rider problem relies on the assumption of homo economicus, a purely rational and selfish individual who always seeks to maximize personal utility¹⁷. However, real-world behavior often deviates from this. Factors like altruism, social norms, community pressure, and a sense of civic duty can motivate individuals to contribute to public goods even without direct personal gain¹⁵, ¹⁶. Charitable donations, for instance, demonstrate voluntary contributions to public goods that contradict pure free-riding behavior¹³, ¹⁴.
• Overstated Explanation: Some critiques argue that the free-rider explanation for certain market phenomena, particularly in areas like resale price maintenance, has been greatly overused and that expansive variants of the theory are flawed¹². It suggests a need for a more nuanced perspective, recognizing that not all instances of benefiting without direct payment are necessarily problematic free riding that requires intervention.
• Difficulty in Measurement: Quantifying the extent of free riding and its precise impact can be challenging. It's often difficult to determine an individual's "true preference" for a public good, which makes it hard to measure how much they are truly free riding¹¹.
• Focus on Market Failure: While the free-rider problem effectively highlights market failures in providing public goods, it sometimes overlooks potential non-market solutions or the role of informal institutions in overcoming collective action problems. Collective action frameworks and game theory offer alternative approaches to analyzing how individuals might coordinate to provide public goods even in the presence of free-rider incentives¹⁰.
• Solutions May Have Drawbacks: The common solutions to free riding, such as taxation or regulation, also come with their own economic and social costs, including potential inefficiencies, administrative burdens, and impacts on individual liberties. For example, imposing fines for non-payment of taxes is a mechanism to combat free riding but comes with enforcement costs⁹.

Free Riding vs. Moral Hazard

Free riding and moral hazard are both concepts within behavioral finance and economic theory that describe situations where individuals or entities might act in ways that are detrimental to others or to the collective, but they stem from different underlying incentives and circumstances.

While free riding concerns the reluctance to contribute to a shared benefit, moral hazard arises when one party's behavior changes after entering into a contract or agreement because they are shielded from the full consequences of their actions. Both concepts address situations where incentives are misaligned, leading to potentially inefficient or undesirable outcomes.

FAQs

Why is free riding a problem?

Free riding is a problem because it leads to the under-provision or non-provision of valuable public goods and services. If too many individuals or entities benefit without contributing, the necessary funding or resources for the good may not be raised, meaning society misses out on benefits it desires.

What types of goods are most susceptible to free riding?

Goods that are non-excludable and non-rivalrous, known as public goods, are most susceptible to free riding. Examples include national defense, clean air, street lighting, and public parks⁷, ⁸. It is difficult to prevent people from enjoying these goods, and one person's consumption doesn't diminish another's, removing the incentive to pay⁶.

How can the free-rider problem be overcome?

The free-rider problem can be overcome through various measures, often involving collective action or government intervention. Common solutions include taxation (making contributions mandatory), regulation (mandating certain behaviors or contributions), social pressures, and, in some cases, privatizing the good if possible⁴, ⁵. For example, governments fund public goods through taxes to ensure everyone contributes³.

Is free riding always bad?

While free riding often leads to under-provision of public goods, some economic perspectives view certain instances of free riding, or positive externalities, in a neutral or even positive light. This view suggests that not every instance of benefiting without payment is necessarily a "problem" that requires intervention, particularly if the overall social benefit outweighs the cost, or if the cost of preventing free riding is too high².

What is the difference between a free rider and someone who simply doesn't want to pay?

A free rider specifically benefits from a good without paying, knowing that others are contributing and they cannot be excluded from the benefit. Someone who simply doesn't want to pay might genuinely not value the good or service enough to justify the cost, and if they are excluded from its use, it's not considered free riding. The core distinction lies in the non-excludability characteristic of the good¹.