The Free Rider Problem of Public Goods
Private companies find it difficult to produce public goods. If a good or service is nonexcludable, like national defense, so that it is impossible or very costly to exclude people from using this good or service, then how can a firm charge people for it?
Visit this website to read about a connection between free riders and “bad music.”
When individuals make decisions about buying a public good, a free rider problem can arise, in which people have an incentive to let others pay for the public good and then to “free ride” on the purchases of others. The free rider problem can be expressed in terms of the prisoner’s dilemma game, which is discussed as a representation of oligopoly in Monopolistic Competition and Oligopoly. Say 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. This sets up the prisoner’s dilemma illustrated in this table.
Contributing to a Public Good as a Prisoner’s Dilemma
|Samuel (S) Contribute||Samuel (S) Do Not Contribute|
|Rachel (R) Contribute||R pays $4, receives $6, net gain +$2S pays $4, receives $6, net gain +$2||R pays $4, receives $3, net gain –$1S pays $0, receives $3, net gain +$3|
|Rachel (R) Do Not Contribute||R pays $0, receives $3, net gain +$3S pays $4, receives $3, net gain –$1||R pays $0, receives $0S pays $0, receives $0|
If neither Rachel nor Samuel contributes 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), while Samuel incurs no cost, and yet he also receives $3 of benefit. In this outcome, Rachel actually loses $1 while Samuel gains $3. A similar outcome, albeit 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). There is a dilemma with the Prisoner’s Dilemma, though. See the Work it Out feature.
The difficulty with the prisoner’s dilemma arises as each person thinks through his or her strategic choices.
Step 1. Rachel reasons in this way: If Samuel does not contribute, then I would be a fool to contribute. However, if Samuel does contribute, then I can come out ahead by not contributing.
Step 2. Either way, I should choose not to contribute, and instead hope that I can be a free rider who uses the public good paid for by Samuel.
Step 3. Samuel reasons the same way about Rachel.
Step 4. When both people reason in that way, the public good never gets built, and there is no movement to the option where everyone cooperates—which is actually best for all parties.