Finance Glossary

Macroeconomic Terms: Free Rider Problem

Macroeconomic Terms: Free Rider Problem

Image Credit: Minseong Kim (CC by 4.0)

In economic policy, a free rider, is a type of market failure in which a person or entity takes advantage of a public good without paying for it, like a bus passenger that does not pay their ticket. The free rider problem only applies when supply is not significantly diminished by the number of people using the public good and consumption cannot easily be restricted.

 

The most common example of a free rider is a person or corporation not paying their proper share of taxes to a governmental body. Another example would be a partly unionized workforce in which some workers benefit from union activity (i.e. improved work environment, increased wages) without having to be a member of the union itself. A more informal case would be a team worker who doesn’t pull their weight.

 

A large amount of free riders can cause depletion of tax base, natural resource exploitation and ultimately a disappearance of the good’s supply. Since free riders often refer to public goods, it is usually the government’s job to prevent the behavior. In the United States, this takes the form of the Internal Revenue Service. Currently, the criminal act of evading or defeating tax can lead to a maximum penalty of five years in prison and/or a $250,000 fine. If the entity is a corporation, the fine goes up to $500,000.
The free rider problem is related to the behavioral concept known as the Tragedy of the Commons, in which a seemingly inexhaustible public resource is depleted through overuse. The concept derives from the work of Victorian economist William Forster Lloyd, who used the model of a public field being overgrazed by cattle. The term was popularized in the 1960s by ecologist Garrett Hardin. A real life example of the Tragedy of the Commons occurred in the same decade in Newfoundland: new fishing technologies led to rapid depletion of stock that had supported the area for hundreds of years.

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