Free rider problem

In economics, collective bargaining, psychology, and political science, "free riders" are those who
consume more than their fair share of a public resource, or shoulder less than a fair share of the costs of
its production. Free riding is usually considered to be an economic "problem" only when it leads to the
non-production or under-production of a public good (and thus to Pareto inefficiency), or when it leads
to the excessive use of a common property resource. The free rider problem is the question of how to
limit free riding (or its negative effects) in these situations.

The name "free rider" comes from a common textbook example: someone using public transportation
without paying the fare. If too many people do this, the system will not have enough money to operate.

Free riding is also a term used by brokerages when a client purchases shares beyond his or her means.
Free riders are those who purchase shares and then do not pay for them. (See margin.)

Politics
A common example of a free rider problem is defense spending: no one person can be excluded from
being defended by a state's military forces, and thus free riders may refuse or avoid paying for being
defended, even though they are still as well guarded as those who contribute to the state's efforts.
Therefore, it is usual for governments to avoid relying on volunteer donations, using taxes and, in some
countries, conscription instead.

Government is indeed the primary mechanism by which societies address free rider problems. In
addition to fiscal measures noted above, regulation is another form of collective action taken by
governments to resolve free riders problems such as environmental degradation or excessive resource
use.

The free rider problem is also one justification for the existence of governments which provide public
goods. Some ideologies, such as libertarian capitalism, are often rebuked, because in such a system all
property in a society would be privately owned, away from any state involvement or regulation.
Libertarians such as Lysander Spooner suggest that competition between mutual insurance companies,
voluntarily patronized by property owners, could provide a practical alternative to government
monopoly on protection over a particular territory.

Bargaining
The free rider problem has deep roots in more general bargaining, and issues to do with incentive
compatibility. That is to say that, when involved in bargaining problems, players may often bid less than
they are prepared to pay in the hope of improving their own position. This creates problems because it
is impossible to discover the players' true demand payoff curves, and therefore inefficient allocation of
resources is likely to result.

In the context of labor unions, free rider means an employee who pays no union dues or agency shop
fees, but nonetheless receives the same benefits of union representation as dues-payers. Under U.S.
law, unions owe a duty of fair representation to all workers that they represent, regardless of whether
they pay dues. Free riding has been a point of legal and political contention for decades.

Example
Suppose there is a street, on which 25 small businesses are run, and which suffers from a serious litter
problem that detracts customers. It costs $100 annually for each business to keep the front of their
store clean. If a store owner decides to keep the front of their store clean, all businesses on the street
will have improved sales. Suppose every business on the street will have a $10 increase in annual sales
for each business that decides to keep the front of their store clean. If more than ten businesses clean
their storefronts, then all of the businesses will make more money, including the businesses that clean.
If some businesses clean but fewer than ten do so, then the businesses that clean will lose money, while
the businesses that do not clean will gain money.

If everyone were to keep the front of their store clean, every business would benefit: a $250 increase in
sales with a cost of $100 yields a $150 gain. However, an individual business could save $100 by not
doing the cleaning, yet suffer only $10 for their defection, yielding a $240 gain, which is greater than
they would have if they cooperated. Despite the fact they may be prepared to contribute $100, they can
avoid doing so in hope that others in the street will clean anyway, and they receive the benefit for no
personal expense.

Thus, under these assumptions, at any given point, any businesses will benefit more by not keeping the
front of their stores clean. As a result, it may happen that no business will clean the street in front of
their store. Such a situation would be the Nash equilibrium. This is despite the fact that allocative
efficiency would be improved if they had cooperated.

Solution

One common solution to the problem is to contractually bind the 25 businesses to make them behave
like a single entity. A vote could be taken so that if the answer is yes, everyone will be forced to pay
regardless of their individual support. Contractual obligation in this problem provides the same function
as a government in providing public services like military defense.

Problems

The solution suggested above is not without its problems. In most real-life scenarios, the utility for the
25 businesses varies from one to another, each benefiting incongruently. In some cases, such a good
may even be considered by some to have negative utility. Further contributing to the payoff asymmetry,
cultural norms of social reciprocity may influence one's willingness to cooperate or defect in a public
goods game. In other words, one may value the actual act of cooperating with their neighboring
businesses to a greater extent than they value the additional money they would get for defecting.