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## Microeconomics

### Unit 9: Lesson 4

The four types of goods: private goods, public goods, common resources, and natural monopolies

# What is a free rider?

Not everybody who benefits from a public good contributes to its creation or maintenance.

## Key points

• A free rider is someone who wants others to pay for a public good but plans to use the good themselves; if many people act as free riders, the public good may never be provided.
• Markets often have a difficult time producing public goods because free riders attempt to use the public good without paying for it.
• The free rider problem can be overcome through measures that ensure the users of a public good pay for it. Such measures include government actions, social pressures, and collecting payments—in specific situations where markets have discovered a way to do so.

## What is a free rider?

Private companies find it difficult to produce public goods. If a good or service is nonexcludable—like national defense—it is impossible or very costly to exclude people from using the good or service. So how can a firm charge people for it?
When individuals make decisions about buying a public good, a free-rider problem can arise—people have an incentive to let others pay for the public good and then to “free ride” on the purchases of others.
The best way to pay for public goods is to find a way of ensuring that everyone will make a contribution, thus preventing free riders. For example, if people come together through the political process and agree to pay taxes and make group decisions about the quantity of public goods, they can defeat the free rider problem by requiring—through the law—that everyone contribute.

## Social pressures and personal appeals

In some cases, social pressures and personal appeals can be used—instead of the force of law—to reduce the number of free riders and to collect resources for the public good.
For example, neighbors sometimes form an association to carry out beautification projects or to patrol their area after dark to discourage crime. In low-income countries, where social pressure strongly encourages all farmers to participate, farmers in a region may come together to work on a large irrigation project that will benefit all.
Many fundraising efforts, including raising money for local charities and for the endowments of colleges and universities, also can be viewed as an attempt to use social pressure to discourage free riding and to generate an outcome that will produce a public benefit.

## Why do people choose to be free riders?

The free rider problem can be expressed in terms of the prisoner’s dilemma game. Imagine that two people are thinking about contributing to a public good: Rachel and Samuel. When either of them contributes to a public good—such as a local fire department—their personal cost of doing so is $4 and the social benefit of that person’s contribution is$6.
Because society’s benefit of $6 is greater than the cost of$4, the investment is a good idea for society as a whole. The problem is that—while Rachel and Samuel pay for the entire cost of their contribution to the public good—they receive only half of the benefit because the benefit of the public good is divided equally among the members of society.
Contributing to a public good as a prisoner’s dilemma
Samuel (start text, S, end text) contributesSamuel (start text, S, end text) does not contribute
Rachel (start text, R, end text) contributesstart text, R, end text pays $4, receives$6, net gain +$2start text, R, end text pays$4, receives $3, net gain –$1
start text, S, end text pays $4, receives$6, net gain +$2start text, S, end text pays$0, receives $3, net gain +$3
Rachel (start text, R, end text) does not contributestart text, R, end text pays $0, receives$3, net gain +$3start text, R, end text pays$0, receives $0 start text, S, end text pays$4, receives $3, net gain –$1start text, S, end text pays $0, receives$0
If neither Rachel nor Samuel contribute to the public good, then there are no costs and no benefits of the public good.
Suppose, however, that only Rachel contributes, while Samuel does not. Rachel incurs a cost of $4, but receives only$3 of benefit—half of the total $6 of benefit to society. Samuel incurs no cost, yet he also receives$3 of benefit. In this outcome, Rachel actually loses $1 while Samuel gains$3. A similar outcome, but with roles reversed, would occur if Samuel had contributed, but Rachel had not.
Finally, if both parties contribute, then each incurs a cost of $4 and each receives$6 of benefit—half of the total \$12 benefit to society.
The difficulty with the prisoner’s dilemma arises as each person thinks through his or her strategic choices.
1. Racheal reasons that if Samuel does not contribute, then she would be a fool to contribute. However, if Samuel does contribute, then she can come out ahead by not contributing.
2. Either way, she decides she should choose not to contribute and instead hope that she can be a free rider who uses the public good paid for by Samuel.
3. Samuel reasons the same way about Rachel.
4. When both people come to the conclusion it would be unwise to contribute, the public good never gets built, and there is no movement to the option where everyone cooperates—which is actually best for all parties.

## Review questions

• What is the free rider problem?
• Explain why the federal government funds national defense.

## Critical-thinking questions

• How do public television stations, like PBS, try to overcome the free rider problem?
• Radio stations, tornado sirens, light houses, and street lights are all public goods in that they are nonrivalrous and nonexclusionary. Why do you think the government provides tornado sirens, street lights, and light houses but does not provide radio stations—other than PBS stations?

## Problems

Becky and Sarah are sisters who share a room. Their room can easily get messy, and their parents are always telling them to clean it up. There are the costs and benefits to both Becky and Sarah of taking the time to clean their room:
• If both Becky and Sarah clean, they each spend two hours and get a clean room.
• If Becky decides not to clean and Sarah does all the cleaning, then Sarah spends 10 hours cleaning and Becky spends 0. Sarah is exhausted.
• If Sarah decides not to clean and Becky does all the cleaning, then Becky spends 10 hours cleaning and Sarah spends 0. Becky is exhausted.
• If both girls decide not to clean, they both have a dirty room.
What is the best outcome for Becky and Sarah? What is the worst outcome? Hint: It will help you to construct a prisoner’s dilemma table.
Explain what it is about Becky’s and Sarah’s reasoning that will probably lead them both to choose the worst outcome.

## Want to join the conversation?

• What is the answer to the second 'Critical-thinking' question? Is it that the positive externalities are so great that they outweigh any free-riding, whereas the positive externalities of a radio station do not outweigh the free-riding?