Why Is a Free Rider a Type of Market Failure?
Learn how the free rider problem illustrates a fundamental market failure, where individual incentives hinder efficient resource provision.
Economic efficiency describes how effectively a market or system allocates its limited resources to fulfill the needs and desires of consumers and producers. It measures the value created from inputs and outputs and how this value is distributed among participants. In a free market, the activities of economic agents can achieve high efficiency. The concept of economic efficiency is broadly applicable to decision-making across various fields.
Understanding Free Riders
A free rider is an individual who benefits from a good or service without contributing to its cost. Free riders have little incentive to contribute to a collective resource because they can enjoy its benefits even if they do not pay. This economic problem occurs when those who benefit from public goods do not pay for them or underpay.
The underlying incentive for free riding stems from rational choice theory, which suggests that people make choices they believe will provide the greatest benefit to themselves. If a service or resource is available for free, a consumer will often choose not to pay for it. This individual pursuit of self-interest, while seemingly logical, can lead to a situation where the producer of the resource is not adequately compensated. Consequently, free riding can reduce the funding necessary to produce and maintain collective goods and services.
Understanding Market Failure
Market failure occurs when the allocation of goods and services by a free market is not efficient. This leads to a net loss of economic value, meaning resources are not distributed optimally. In such instances, the market mechanism alone does not achieve the best possible outcome for society.
General conditions under which market failure can arise include situations where there are externalities, information asymmetry, or imperfect competition.
Public Goods and the Free Rider Problem
Public goods are characterized by two primary features: non-excludability and non-rivalry. Non-excludability means it is impractical or too costly to prevent individuals from using the good, even if they have not paid for it. An example is national defense, where it is impossible to exclude any citizen from its protection. Non-rivalry means that one person’s consumption of the good does not reduce its availability for others. For instance, many people can simultaneously enjoy the benefit of a streetlight without diminishing its light for others.
These characteristics create the conditions for the free rider problem. Because a public good is non-excludable, individuals can benefit from it without contributing to its cost. This leads to a situation where people have an incentive to let others pay for the public good and then “free ride” on their contributions.
For example, if a coastal town builds a lighthouse, ships from various regions and countries benefit from its guidance even if they do not contribute to its expenses. Similarly, a public radio station relies on donations from listeners, but many can listen without donating. The difficulty in charging individuals for their consumption of non-excludable and non-rivalrous goods makes it challenging for private companies to produce them.
How Free Riding Leads to Market Failure
The free rider problem directly contributes to market failure by causing the under-provision or even the complete non-provision of public goods. When individuals can benefit from a good without paying, private producers lack the financial incentive to supply it.
This behavior leads to insufficient funding for public goods, as individuals choose not to contribute financially while still benefiting from them. As a consequence, the shared resource may be under-produced, overused, or degraded. The resource may eventually cease to be available if the costs become excessive without sufficient contributions. This under-provision represents an inefficient allocation of resources.
The collective welfare of society suffers because adequate resources are not allocated for the creation or maintenance of these essential goods. For instance, if enough people refuse to pay for a public good or its upkeep, the service may not be provided at all. This outcome is a market failure because the market, left to its own devices, fails to provide goods that are socially desirable and beneficial. The costs might grow over time, increasing the total expense of providing and maintaining a shared resource.