The Free Rider Problem occurs when there is a good (likely to be a public good) that everyone enjoys the benefits of without having to pay for the good. The free-rider problem leads to under-provision of a good or service and thus causes market failure.
The Free Rider Problem Explained
The Free Rider Problem occurs because of the failure of individuals to reveal their real or true preferences for the public good through their contributions.
For example, when a town wants to construct a vital bridge, it will ask the people of the town if they will contribute towards the construction costs. Everyone says they will, and they also know that even if they don’t contribute individually, other people will contribute enough or the local municipality will find a way to pay for the bridge. This means no one will want to contribute towards the building of a bridge because they know that even if they don’t participate in paying for the bridge, someone else will, and the bridge will get built anyway.
This situation leads to the underproduction of such goods. Since these goods are non-rival, it means that they cannot exclude other people from consuming them. For example, you cannot prevent anyone from utilizing the benefits of a street lamp, even though they haven’t paid for it.
Public goods have two characteristics that set them apart; they are non-rival and non-exclusive. Non-exclusive means once you provide it for everybody, you can’t stop people from using it. And non-rival means that the consumption of the good doesn’t reduce the availability of the good for other people.
As a result, private firms have no incentive to produce such goods since they can’t make everyone pay for them.
Wikipedia is another example of the Free Rider problem – few people contribute (financially or otherwise), but everyone gets to use it.
The Free Rider Problem Example
There is a project to build a bridge that would benefit 50 people and each one of those 50 people is only willing to pay $100 towards the project. However, the bridge costs only $2,000 to build. This means if everyone contributed $100, there would be an excess of $5,000.
What ends up happening is that every individual tries to lower the value of the bridge. They know that they would get to use the bridge even if they didn’t pay the same amount as the next person. This goes on until everyone decides to not contribute to the project. This is known as the free rider problem.
Some other examples of the free rider problem
1. Trash Pick Up
If there is trash on a public beach, and someone starts picking up all the trash, then everyone benefits from the cleaner beach. However, this creates an incentive for people to not care about throwing trash since someone else will take care of their mess.
2. National Defense
The government provides defense for all its citizens regardless of much they contribute in taxes.
Solutions to Free Rider Problem
1. Taxation
One solution is to treat all beneficiaries as one consumer and then divide the cost equally. For example, if we have a public good like national defense, we can get everyone to pay for it by using tax revenue to pay for the national defense budget.
2. Soliciting Donations
This can be effective for services that a low cost. People often don’t mind making a small donation towards a garden or a museum. Not everyone will pay, but the generosity of the people that will pay will make up for the free riders.
3. Make a Public Good Private
If you convert a public good into private, then you could force everyone to pay to use it. For example, by erecting a toll on the public bridge, you would force everyone who crosses it to pay for the construction cost.