The Free-Rider Problem in Public Goods Domain.

1.0 Introduction The "free rider problem" occurs in situations, in which a person derives a positive externality from the actions of another that is, a benefit that he did not pay for. This occurs in situations where the beneficial effect of an action is "non-excludable," meaning that the benefits cannot be withheld from people who had nothing to do with the action. 1 Free rider is a very common problem in the area of public good; a public good has a classic free rider problem because of its characteristic which is the non-excludability which mean no one can be excluded from getting the benefit of a good and also non-rival in consumption, whereby benefiting from a good or a service does not reduce the amount available to other. The easiest and most common example of public good is national defense, it benefits everyone, the fact that a person is protected in no way detracts from the fact the other person is also protected. Every citizen is protected just as much every other citizen, and the government cannot exclude anyone from its protection through the national defense.2 The problem with public good is that private producers usually dont have any incentive to provide or produce public good or produce them at the right amount. For a private firm that
1

ONeill, B. (2007). Solving The Problem of Free Riding Problem. Ludwig Von Mises Institute. Retrieved at http://mises.org/daily/2769 on 11 December 2013
2
th

Case, E.K., Fair, R.C., & Oster, M.O. (2013) Principle of Microeconomics 11 Edition. England, UK: Pearson.

focuses on profit making, to produce a good and make a profit, it must be able to withhold that good from those who do not pay. In short, making the good excludable. Burger King can make money selling burgers only because customer would not get the burger unless they pay for it first. If the burger is non-excludable, or if payment is optional, Burger King would not be in business for long. This is because not everybody would be willing to pay for the cost of producing the burger since they can get it without paying. The unwillingness of paying or contributing to the production of goods will create market failure. 2.0 The Problem with Free-Rider Market failure situation Foldvary (1994) gave an example of how severe this market failure situation is through his story about the entrepreneur who wanted to build a dam.3 Suppose there is a valley, call it The Valley of INPUMA with 100,000 residents reside in it. Through the valley there runs a river which is apt to flood periodically. Almost all residents would like to have a dam built to protect them against the flooding. So, an entrepreneur, Safwan, sees a profitable opportunity in building the dam. Unfortunately, Safwan calculates that the cost of buying the land, including compensating the users of the sites for the loss of their homes, farms and wildlife would exceed the estimated amount he could earn just from the water and recreational value offered by the

Foldarvy, F. (1994). The Fallacy of The Market Failure Argument. (pp. 2) Public Goods and Private Communities. England. UK: Edward Elgar Publishing Company

dam. But, he is very sure that the residents of The Valley of INPUMA would be willing to pay an annual charge to be protected from the flooding, enough to make this venture profitable. Safwan then proceed to ask each household to pledge RM100 per year for the indefinite future for the benefits of the dam, which is less than the insurance they need to pay to be compensated for the risk of flooding. It is surely in the interest of each household to pay this amount, but to his surprise, Safwan finds that no one wants to pledge the RM100. He then asks his economist friend for an explanation. The economist explain that the residents of The Valley of INPUMA would find the dam beneficial, but they also realize that, if one does not sign up, and others do, the resident will benefit from the flood protection as much as others. So, why sign up? Let the others pay and they can still enjoy the benefit of protection from the flooding. These are the free riders. Safwan then decided that, as an entrepreneur, he shall not build the dam if no one pays. The incentive to be a free-rider is so strong that the market fails to produce a dam. This is the effect of free rider that is really common public in the public good domain. The Tragedy of the Common Free rider problem is also said to occur when there is overconsumption of shared resources. It is also known as the tragedy of the common.4 Imagine a situation where fishermen in fishing area, lets say a lake where every fishermen can fish. Fisherman A, B and C, all fish in the same lake and sell their catch in the market. Fishermen A and C only catch the fish up to certain amount of profit because the wanted to preserve sustainable fish stocks in the lake.
4

Pettinger, J.T. (2011). The Free Rider Problem. Economics Help. Retrieved at http://www.economicshelp.org/blog/1626/economics/ on 12 December 2013

But Fisherman B did not care and he catch as many fish as he can to maximize his profit, because he knows that Fisherman A and C will do the whole preserving the fish population thing so he take advantages of this and free ride on the benefits of Fisherman A and C who are preserving the amount of fish in the lake. Lets say that Fisherman C finds out that Fisherman B did not really catch es the fish up to the sustainable amount because he free-rides on the benefits of him and Fisherman A preserving the fish. So Fisherman C thought why shouldnt he do that too and ma ximize his profit. Then Fisherman A also found out about this and no longer catches the fish up to the amount that would sustain the fish stocks. The fish stocks soon depleted and there are no more resources in the lake. This is one of the examples that the tragedy of the common causes by free-rider. Inefficient underproduction of the goods Due to the non-excludable nature of public goods, its often suffer from underproduction due to free rider taking advantage of good provided by others. A simple example is from a situation in a group experiment of foods. Imagine a group of 15 people of the same microeconomic class. For the first week, each of these 15 individual was told to bring foods, any kind of foods, to the class enough for 15 people. Everyone can eat each of these foods regardless what he/she brought to the class. Next week, the experiment continues, but this time, one or two person would not bring the food anymore because they know they still can eat the food brought by others.

The experiment continues to the next week, and less people will bring food to the class because they know that someone else will bring the food and they still can eat the food regardless whether they provide their foods to the class or not. With each week, the production of foods will continue to deplete and up until no one will bring food anymore because each person will free-ride on foods that was brought by others. 3.0 Solutions to the Free Rider Caused Problem Taxation One of the solutions to the free-rider problem is through tax. The governments treats her many beneficiaries as one consumer and then divide the cost equally. 5 Take the cost of national defense for instance. The government needs the fund for military purposes so they get the fund through taxes. Lets say Country As national defense cost RM30 billion, this will result in higher taxes for country As taxpayer. So the cost of national defense is paid indirectly by Country As taxpayers. This can ensure that everyone who gets the benefits of national defense pays towards the cost. Without taxation, government funding for public goods have to be obtained through voluntary means and this could create a worst free rider problem. So through taxing the taxpayers income, the government can get the funding needed for public goods such as the national defense while making sure everyone is paying for it.

ibid

Regulations for Public Goods This solution can solve the common resources problem created by the free-rider issue. Lets take the example of the three fishermen and the lake. The source of the fish was depleted because Fishermen B free-rides on the benefits of preservation act done by Fishermen A and C. When Fishermen A and C knows, they too start to maximize their profit and no longer try to sustain the fish stocks in the lake. This problem can be solved through a governing body or local authority intervention, for example the local authority regulates a law to the amount of fish that the three fishermen can catch and what size of fish that they can keep. Through laws and regulation, all of the fishermen will have to abide the rules and only catch fish up to the amount that they were allowed to. Appealing to people altruism Altruism is the unselfish regard for or devotion to the welfare of others. It is a feeling and behavior that show a desire to help other people and a lack of selfishness.6 Most altruists have held that each person has an obligation to further the pleasures and alleviate the pains of other people. The same argument holds if happiness, rather than pleasure, is taken as the end of life. 7 If we can appeal to peoples altruism, there would not be any issues of lack of incentive or funds to provide the public goods, because people are willing to pay even though they know
6

Altruism. (n.d) In Merriam Webster Dictionary online. Retrieved from http://www.merriamwebster.com/dictionary/altruism

7

Altruism. (n.d) In Merriam Webster Concise Encyclopedia online. Retrieved from http://www.merriamwebster.com/concise/altruism?show=0&t=1387182371

that others dont pay and they do this for the benefits of themselves because they enjoy the goods For example the goods of visiting a free public museum, the museum may be able to raise funds by asking for donations if the visitors enjoy the visit. There will probably be free riders who dont make a donation. But enough people may be willing to donate for the funds of the museum if the museum is really enjoyable. But this solution usually effective with services with low cost. People wouldnt mind to donate RM5 for the free museum service for others but if they have to donate RM200 for national defense, surely they wont be that generous. One other example, if someone robs a persons neighbor, it is in his self-interest that the criminal be caught and punished, whether or not his neighbor donated to the police department. His neighbor may be the victim today, but if the thief remains free, he may as well be the victim tomorrow. In other words, the violation of his neighbors rights is a threat to him, and he definitely has an interest in removing such threats. So even though he know his neighbor did not make any donations towards the police department, he will still give some donations to cover for the services in interest of his own safety. Privatization The problem caused by the free rider problem can also be solved through privatization. For example, everyone can enjoy going to a park even though not everybody pays for the maintenance of the park. The cost of park maintenance can be a burden and since it is public goods no one bothers to pay/donate to maintain the beauty and the cleanliness of it. If a

private firm were to take charge of the park and erect a high barrier, limit the entrance and charge for the entrance, it will become a private good. The fund from the park charges can be use to maintain the cleanliness and also can be use to build more infrastructure in the park. People may not like that they were being charge but for those who really enjoy going to the park would not mind to pay as long as it is maintained and clean.

Bibliography 1. Altruism. (n.d) In Merriam Webster Dictionary online. Retrieved from http://www.merriam-webster.com/dictionary/altruism 2. Altruism. (n.d) In Merriam Webster Concise Encyclopedia online. Retrieved from http://www.merriam-webster.com/concise/altruism?show=0&t=1387182371 3. Case, E.K., Fair, R.C., & Oster, M.O. (2013) Principle of Microeconomics 11 th Edition. England, UK: Pearson. 4. Foldarvy, F. (1994). The Fallacy of The Market Failure Argument. (pp. 2) Public Goods and Private Communities. England. UK: Edward Elgar Publishing Company 5. ONeill, B. (2007). Solving The Problem of Free Riding Problem. Ludwig Von Mises Institute. Retrieved at http://mises.org/daily/2769 on 11 December 2013 6. Pettinger, J.T. (2011). The Free Rider Problem. Economics Help. Retrieved at http://www.economicshelp.org/blog/1626/economics/ on 12 December 2013

UNIVERSITI MALAYA

MASTER OF PUBLIC POLICY MICROECONOMICS FOR PUBLIC POLICY 1

The Free Rider Problem in Public Goods Domain

Prepared for: Mr. Abdullah Azmi Abd Khalid

Prepared by: Mohd Safwan Salleh ZGA 130009