Free Rider
It is an economic issue where people benefit from goods/services they did not pay to use.
What Is the Free Rider Problem?
The Free Rider problem is an economic issue where people benefit from goods/services they did not pay to use. They are most commonly found within the public goods of a country and cause the private sector to back off.
Economists blame the failure of the free market on the Free Rider problem simply because people who did not pay for goods or services get the same benefits as those who did pay for those goods and services.
The job of the free market is to distribute goods/services fairly and evenly throughout the economy. However, when people benefit without paying, this highlights a failure of the free market.
For example, an individual pays for property maintenance. By doing so, they raise the value of their house and help appreciate the property value of their neighbors.
Even though the neighbors did not pay for said service, they still benefited from their property's increasing value simply because someone else paid for it.
This unfair benefit gained by the neighbors is referred to as the free-rider problem in economics. Think of ways people do free-riding in your community. Maybe even you could have unintentionally benefitted from free riding.
An important observation is that people often do not even realize they benefit from free riding. This is a significant reason why free riding usually occurs in economies.
Public Goods and the Free Rider Problem
Public Goods are goods that are available to anyone within the society.
Examples:
- Water
- Air
- National Defense
Since they are open to anyone within a society, public goods are often a breeding ground for the free-rider problem. This is primarily because they are both non-rivalrous and non-excludable.
- Non-rivalrous: The use of the good or service by one does not affect the availability of the good or service for another person
- Non-excludable: Do not have the ability to stop people from consuming the good or service
When these two characteristics are achieved, they allow the free-rider problem to develop within that particular environment. These were the main reasons public goods are common ground in finding free-riding issues.
Private goods also exist in our economy. The two main distinctions between public and private goods are that private goods are rivalrous and excludable, while public goods are non-rivalrous and non-excludable.
For example, cakes baked by a bakery. Every time a person purchases a cake from the bakery, their inventory of cakes in the bakery for the day decreases. Therefore, each purchase affects the availability of goods for the overall population.
To consume said cake, the consumers need to pay the bakery store, and by adding a payment scheme, the bakery makes its goods excludable so that not everyone can eat the cake without a purchase. These two qualities make the cake a private good.
There is a multitude to learn about rivalrous and excludability. If you want further to educate yourself about these characteristics of goods/services, read this webpage.
Educating yourself about the various aspects of rivalry and excludability can help you learn more about the economy.
There are many benefits to public goods. First, the abundance of public goods can help improve the quality of life in society.
By providing access to goods/services that everyone can benefit from, a public good helps improve the lifestyle of everyone in the community. It can even bring the community together around a common cause.
Example
An excellent example of the benefits of a public good would be a public park. It is a perfect public good because it allows kids to play baseball and adults to enjoy leisurely walks.
Accessibility to such activities is priceless and therefore helps improve the quality of life in your community. In addition, access to amenities such as these benefits improves the overall public happiness within a country.
It is a significant advantage that America is a country that has a vast amount of public parks that people can visit. Access to such places is one of the reasons why the quality of living in America is high.
Public Goods are an essential part of economics, and it is vital to understand the general topic well. In addition, an understanding of public goods helps identify benefits to society.
If you would like to read more about public goods in an economic sense, you can use this website to learn more.
When the Free Rider Problem Arises
Since public goods are non-rivalrous and non-excludable, the free market tends to stay away from them. Companies identify the vast amount of lost revenue they can experience by entering the industry and tend to avoid participating.
From the corporate standpoint. Why would you willingly enter an industry that you know is full of consumers who can take advantage of a product/service without paying for it?
Consequently, someone other than the free market needs to step in, and that someone, in most cases, is the government.
Amenities such as public parks and wastewater treatment are examples of public goods. If the free market is unwilling to provide them, consumers will lose out, and society will be negatively affected.
These amenities are essential to maintain because they help improve the quality of life of all citizens.
Since the free market will not get involved, the government must take proper action and provide said amenities. This is why you often see public parks and even your community park maintained by the local governing body.
Along with the free market refusing to take over, the free-rider problem can also arise due to the:
1. Goods/Services consumed in unlimited amounts
An unlimited amount of a resource automatically becomes non-rivalrous since an individual’s consumption does not halter another person from consuming the good/service.
2. When someone has to maintain the good/service
This is because resources such as these often become shared resources among communities.
Economics states that all these conditions drive away from the free market. Subsequently, since anyone can use public goods, another issue that arises from a free-rider problem is the Tragedy of commons.
This is a situation where individuals share access to specific resources. However, since no one is held accountable for maintaining the resources, people inadvertently deplete the quantity and quality of the resources, thus worsening the condition over time.
A key example is cattle grazing. Cattle grazers share common grazing grounds for their cattle.
Since none of them were held accountable, they all acted in self-interest and let their cattle graze away till the land could no longer provide proper nutrition for the cattle.
Problems Caused by Free Riding
There is a multitude of problems caused by Free riding. However, they all have a common theme which is economic inefficiency.
1. Underproduction
It has been found that free-riding often causes the underproduction of public goods since there is no easy way to measure how many people will use goods/services.
For example, a community decides to construct a new soccer field. The community leads request donations for the construction. However, people do not donate, assuming someone else will donate accordingly.
2. Overconsumption
Overconsumption is another issue caused by free riding. When the good/service is free to benefit, people will take advantage of that offer and reap the benefits without shelling out their share of the costs.
The implementation of streetlights is another prime example. While constructing the street lights, the community assumes only a few people will use the amenity. However, people who did not pitch in started walking outside simply because of the new streetlights.
You may assume these issues do not seem that trivial. However, you would find yourself to be incorrect. These problems raised by free-riding cannot be taken lightly. They cause an inaccurate distribution of goods/services in our economy.
An inaccurate distribution of goods and services is a significant issue for the economy because people who do not pay for certain goods/services enjoy the same or more benefits as those who pay.
The public and the private sector would notice this unjust distribution of benefits and act so that the country's overall economy would be harmed.
The public would join those who do not pay for goods/services, and therefore would cause a decrease in revenue for businesses.
The private sector would notice and avoid markets with free-riding issues, causing underproduction and overconsumption.
Solutions to the Free Riding Problem
Although the free-rider problem may seem like a light issue, it is essential to eliminate it. This is because if it is kept within specific industries, it can cause consumers' consumption to drop too low.
This is natural to occur because people will not spend money for a good/service when they notice others receiving the same benefits without spending any money.
In addition, the Free Rider Problem also demotivates companies from producing adequate amounts of goods/services in that specific sector.
Companies do not see the merit in entering a sector where they know people can enjoy the benefits of the company’s goods/services without paying for them.
Due to the lack of interest by the private sector, the government needs to step in and implement policies that eliminate free-rider problems within specific industries.
Without Government intervention, many public goods would become inaccessible to society, lowering society's general quality of life. Some examples of such policies are:
1. Taxation
Mandatory taxation is an effective way of reducing the free-rider problem. This is because the government reduces the number of free riders by forcing everyone to pay for public services or goods.
For example, the various Federal and State taxes that get deducted from one’s paycheck. All that money does not just disappear; instead, it gets used to pay for public services/goods such as parks, water treatment plans, and national defense.
2. Converting the Public good to Private
This is another effective measure to reduce the free-rider problem. By making a good/service private, the good/service becomes rivalrous and excludable.
It is a tremendous advantage to countries' economies if these solutions are enacted. They allow the public to enjoy the benefits of particular goods/services without worrying about the production aspect of the goods/services. This is mainly due to governments stepping up.
At the same time, the pirate sector does not have to worry about entering markets where they would lose money since the government now takes over the responsibility of producing the goods/services for public consumption.
Even though most free-rider problems are solved via government intervention, the problems can also be solved via social pressure from the community.
When people within a community notice members are receiving the same benefits as them without taking part in the costs, they may speak to those members about pitching in when it comes to the costs.
At the same time, when people notice that they are revealing benefits without taking up the costs like others, they may feel inclined to pitch in and start taking part in the costs. These situations solve the issue automatically.
For example, the High Altitude Observatory (US National Center for Atmospheric Research). The HOA sets standards for the whole community to abide by. That way, everyone maintains their property well and receives benefits in appreciation of their property's value.
On a related note, accounting is a great way to learn how our country's tax system works. Taxes are a large part of accounting. Develop a fundamental understanding of the three financial statements.
You could do yourself a favor by improving your critical thinking skills and learning to analyze the company’s financial documents.
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