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In the social sciences, the free-rider problem is a type of market failure that occurs when those who benefit from resources, public goods (such as public roads or hospitals), or services of a communal nature do not pay for themor under-pay. Free riders are a problem because while not paying for the good (either directly through fees or tolls or indirectly through taxes), they may continue to access or use it. Thus, the good may be under-produced, overused or degraded.
The free-rider problem in social science is the question of how to limit free riding and its negative effects in these situations. The free-rider problem may occur when property rights are not clearly defined and imposed.The free-rider problem is common with goods which are non-excludable (meaning that non-payers cannot be stopped from getting use of or benefits from the good), including public goods and situations of the tragedy of the commons. A free rider may enjoy a non-excludable good such as a government-provided road system without contributing to paying for it. For another example, if a coastal town builds a lighthouse, ships from many regions and countries will benefit from it, even though they are not contributing to its costs, and are thus "free riding" on the navigation aid.
Although the term "free rider" was first used in economic theory of public goods, similar concepts have been applied to other contexts, including collective bargaining, antitrust law, psychology and political science.For example, some individuals in a team or community may reduce their contributions or performance if they believe that one or more other members of the group may free ride.
Free riding is a problem of economic inefficiency when it leads to the underproduction or overconsumption of a good. For example, when people are asked how much they value a particular public good, with that value measured in terms of how much money they would be willing to pay, their tendency is to under-report their valuations.Goods that are subject to free riding are usually characterized by the inability to exclude non-payers. Indeed, if non-payers can be excluded by some mechanism, the good may be transformed into a club good (e.g. if an overused, congested public road is converted to a toll road, or if a free public museum turns into a private, admission fee-charging museum). This problem is sometimes compounded by the fact that common-property goods are characterized by rival consumption. Not only can consumers of common-property goods benefit without payment, but consumption by one imposes an opportunity cost on others. This will lead to overconsumption and even possibly exhaustion or destruction of the common-property good. If too many people start to free ride, a system or service will eventually not have enough resources to operate. Free-riding is experienced when the production of goods does not consider the external costs, particularly the use of ecosystem services.
Economists widely believe that Pareto-optimal allocation of resources in relation to public goods is not compatible with the fundamental incentives belonging to individuals.Therefore, the free-rider problem, according to most scholars, is expected to be an ongoing public issue. For example, Albert O. Hirschman believed that the free-rider problem is a cyclical one for capitalist economies. Hirschman considers the free-rider problem to be related to the shifting interests of people. When stress levels rise on individuals in the workplace and many fear losing their employment, they devote less of their human capital to the public sphere. When public needs then increase, disenchanted consumers become more interested in collective action projects. This leads individuals to organize themselves in various groups and the results are attempts to solve public problems. In effect this reverses the momentum of free riding. Activities often seen as costs in models focused on self-interest are instead seen as benefits for the individuals who were previously dissatisfied consumers seeking their private interests.
This cycle will reset itself because as individuals' work for public benefit becomes less praiseworthy, supporters' level of commitment to collective action projects will decrease. With the decrease in support, many will return to private interests, which with time resets the cycle. Supporters of Hirschman's model insist that the important factor in motivating people is that they are compelled by a leader's call to altruism. In John F. Kennedy's inaugural address he implored the American people to "ask not what your country can do for you; ask what you can do for your country." Some economists (for example, Milton Friedman) find these calls to altruism to be nonsensical. Scholars like Friedman do not think the free-rider problem is part of an unchangeable virtuous or vicious circle, but instead seek possible solutions or attempts at improvement elsewhere.
An assurance contract is a contract in which participants make a binding pledge to contribute to building a public good, contingent on a quorum of a predetermined size being reached. Otherwise the good is not provided and any monetary contributions are refunded.
A dominant assurance contract is a variation in which an entrepreneur creates the contract and refunds the initial pledge plus an additional sum of money if the quorum is not reached. The entrepreneur profits by collecting a fee if the quorum is reached and the good is provided. In game-theoretic terms this makes pledging to build the public good a dominant strategy: the best move is to pledge to the contract regardless of the actions of others.
A Coasian solution, named for the economist Ronald Coase, proposes that potential beneficiaries of a public good can negotiate to pool their resources and create it, based on each party's self-interested willingness to pay. His treatise, The Problem of Social Cost (1960), argued that if the transaction costs between potential beneficiaries of a public good are low—that it is easy for potential beneficiaries to find each other and organize pooling their resources based upon the good's value to each of them—that public goods could be produced without government action.
Much later, Coase himself wrote that while what had become known as the Coase Theorem had explored the implications of zero transaction costs, he had actually intended to use this construct as a stepping-stone to understand the real world of positive transaction costs, corporations, legal systems and government actions:
I examined what would happen in a world in which transaction costs were assumed to be zero. My aim in doing so was not to describe what life would be like in such a world but to provide a simple setting in which to develop the analysis and, what was even more important, to make clear the fundamental role which transaction costs do, and should, play in the fashioning of the institutions which make up the economic system.
Coase also wrote:
The world of zero transaction costs has often been described as a Coasian world. Nothing could be further from the truth. It is the world of modern economic theory, one which I was hoping to persuade economists to leave. What I did in "The Problem of Social Cost" was simply to shed light on some of its properties. I argued in such a world the allocation of resources would be independent of the legal position, a result which Stigler dubbed the "Coase theorem".
Thus, while Coase himself appears to have considered the "Coase theorem" and Coasian solutions as simplified constructs to ultimately consider the real 20th-century world of governments and laws and corporations, these concepts have become attached to a world where transaction costs were much lower, and government intervention would unquestionably be less necessary.
A minor alternative, especially for information goods, is for the producer to refuse to release a good to the public until payment to cover costs is met. Author Stephen King, for instance, authored chapters of a new novel downloadable for free on his website while stating that he would not release subsequent chapters unless a certain amount of money was raised. Sometimes dubbed holding for ransom, this method of public goods production is a modern application of the street performer protocol for public goods production. Unlike assurance contracts, its success relies largely on social norms to ensure (to some extent) that the threshold is reached and partial contributions are not wasted.
One of the purest Coasian solutions today is the new phenomenon of Internet crowdfunding. Here rules are enforced by computer algorithms and legal contracts as well as social pressure. For example, on the Kickstarter site, each funder authorizes a credit card purchase to buy a new product or receive other promised benefits, but no money changes hands until the funding goal is met.Because automation and the Internet so reduce the transaction costs for pooling resources, project goals of only a few hundred dollars are frequently crowdfunded, far below the costs of soliciting traditional investors.
If market provision of public goods is insufficient, then another possible solution is making their provision using non-market means.One frequently proposed solution to the problem is for states to impose taxation to fund the production of public goods. Government provision generally seeks to respond to the free-rider problem within its national boundaries, which gives citizens assurances that other individuals will not be free riding. While taxation ensures that the public good will be provisioned, it does not attempt to address the question of achieving market efficiency. Issues regarding the economic efficiency of government provision are studied by public choice theory and public finance.
Sometimes the government provides public goods using "unfunded mandates". An example is the requirement that every car be fit with a catalytic converter. This may be executed in the private sector, but the end result is predetermined by the state: the individually involuntary provision of the public good clean air. Unfunded mandates have also been imposed by the U.S. federal government on the state and local governments, as with the Americans with Disabilities Act, for example.
A government may subsidize production of a public good in the private sector. Unlike government provision, subsidies may result in some form of a competitive market. The potential for cronyism (for example, an alliance between political insiders and the businesses receiving subsidies) can be limited with secret bidding for the subsidies or application of the subsidies following clear general principles. Depending on the nature of a public good and a related subsidy, principal–agent problems can arise between the citizens and the government or between the government and the subsidized producers; this effect and counter-measures taken to address it can diminish the benefits of the subsidy.
Subsidies can also be used in areas with a potential for non-individualism. For instance, a state may subsidize devices to reduce air pollution and appeal to citizens to cover the remaining costs.
Similarly, a joint-product model analyzes the collaborative effect of joining a private good to a public good. For example, a tax deduction (private good) can be tied to a donation to a charity (public good). It can be shown that the provision of the public good increases when tied to the private good, as long as the private good is provided by a monopoly (otherwise the private good would be provided by competitors without the link to the public good).
The study of collective action shows that public goods are still produced when one individual benefits more from the public good than it costs him to produce it; examples include benefits from individual use, intrinsic motivation to produce, and business models based on selling complementary goods. A group that contains such individuals is called a privileged group. A historical example could be a downtown entrepreneur who erects a street light in front of his shop to attract customers; even though there are positive external benefits to neighboring nonpaying businesses, the added customers to the paying shop provide enough revenue to cover the costs of the street light.
The existence of privileged groups may not be a complete solution to the free rider problem, however, as underproduction of the public good may still result. The street light builder, for instance, would not consider the added benefit to neighboring businesses, leaving the rest of the street dark even when the total combined benefit to neighbors exceeds the cost of additional lamps.
An example of the privileged group solution could be the Linux community, assuming that users derive more benefit from contributing than it costs them to do it. For more discussion on this topic see also Coase's Penguin.
Another example is those musicians and writers who create works for their own personal enjoyment, and publish because they enjoy having an audience. Financial incentives are not necessary to ensure the creation of these public goods. Whether this creates the correct production level of creative works is an open question.
Another method of overcoming the free rider problem is to simply eliminate the profit incentive for free riding by buying out all the potential free riders. A property developer who owned an entire city street, for instance, would not need to worry about free riders when erecting street lights since he owns every business that could benefit from the street light without paying. Implicitly, then, the property developer would erect street lights until the marginal social benefit met the marginal social cost. In this case, they are equivalent to the private marginal benefits and costs.
While the purchase of all potential free riders may solve the problem of underproduction due to free riders in smaller markets, it may simultaneously introduce the problem of underproduction due to monopoly. Additionally, some markets are simply too large to make a buyout of all beneficiaries feasible—this is particularly visible with public goods that affect everyone in a country.
Another solution, which has evolved for information goods, is to introduce exclusion mechanisms which turn public goods into club goods. One well-known example is copyright and patent laws. These laws, which in the 20th century came to be called intellectual property laws, attempt to remove the natural non-excludability by prohibiting reproduction of the good. Although they can address the free rider problem, the downside of these laws is that they imply private monopoly power and thus are not Pareto-optimal.
For example, in the United States, the patent rights given to pharmaceutical companies encourage them to charge high prices (above marginal cost) and to advertise to convince patients to persuade their doctors to prescribe the drugs.[ dubious ] Likewise, copyright provides an incentive for a publisher to act like The Dog in the Manger, taking older works out of print so as not to cannibalize revenue from the publisher's own new works.
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The laws also end up encouraging patent and copyright owners to sue even mild imitators in court and to lobby for the extension of the term of the exclusive rights in a form of rent seeking.
These problems with the club-good mechanism arise because the underlying marginal cost of giving the good to more people is low or zero, but, because of the limits of price discrimination those who are unwilling or unable to pay a profit-maximizing price do not gain access to the good. If the costs of the exclusion mechanism are not higher than the gain from the collaboration, club goods can emerge naturally. James M. Buchanan showed in his seminal paper that clubs can be an efficient alternative to government interventions. [ citation needed ]On the other hand, the inefficiencies and inequities of club goods exclusions sometimes cause potentially excludable club goods to be treated as public goods, and their production financed by some other mechanism. Examples of such "natural" club goods include natural monopolies with very high fixed costs, private golf courses, cinemas, cable television and social clubs. This explains why many such goods are often provided or subsidized by governments, co-operatives or volunteer associations, rather than being left to be supplied by profit-minded entrepreneurs. These goods are often known as social goods. Joseph Schumpeter claimed that the "excess profits", or profits over normal profit, generated by the copyright or patent monopoly will attract competitors that will make technological innovations and thereby end the monopoly. This is a continual process referred to as "Schumpeterian creative destruction", and its applicability to different types of public goods is a source of some controversy. The supporters of the theory point to the case of Microsoft, for example, which has been increasing its prices (or lowering its products' quality), predicting that these practices will make increased market shares for Linux and Apple largely inevitable.
A nation can be seen as a "club" whose members are its citizens. Government would then be the manager of this club. This is further studied in the theory of the state.[ citation needed ]
The impact of social norms on the free-rider problem differs between cultural contexts, which may lead to a variance between results in research on the free-rider problem when applied cross-culturally. Social norms impact on privately and voluntarily provided public goods; however, is considered to have some level of effect on the problem in many contexts. Social sanctioning, for example, is a norm in it of itself that has a high degree of universality.The goal of much research on the topic of social sanctioning and its effect on the free-rider problem is to explain the altruistic motivation that is observed in various societies.
Free riding is often thought only in terms of positive and negative externalities felt by the public. The impact of social norms on actions and motivations related to altruism are often underestimated in economic solutions and the models from which they are derived.
Often on the foundation of game theory, experimental literature suggests that free riding situations can be improved without any state intervention by seeking to measure the effects of various forms of social sanctions. Peer-to-peer punishment, that is, when members sanction other members that do not contribute to the public good by inflicting a cost on "free-riders", is considered sufficient to establish and maintain cooperation.Although such punishment is often considered altruistic because it comes at a cost to the punisher, it is noted that the exact nature of motivation remains to be explored. Whether costly punishment can explain cooperation is disputed. Recent research finds that costly punishment is less effective in real world environments. For example, punishment works relatively badly under imperfect information where people cannot observe the behavior of others perfectly.
Other research finds that social sanctions cannot be generalized as strategic in the context of public goods. Preferences between secret sanctions (untraceable sanctions between players in the game) and standard sanctions (traceable sanctions including feedback between players in an otherwise identical environment) on free riders did not vary significantly. Rather some individuals preferred to sanction others regardless of secrecy.Other research build on the findings of behavioral economics, finds that in a dilemmatic donation game, donators are motivated by the fear of loss. In the game donators' deposits were only refunded if the donators always punish free riding and non-commitment among other individuals. Pool-punishment (everyone loses their deposit if one donator doesn't punish the free rider) provided more stable results than punishment without consideration of the consensus of the group. Individual-to-individual peer punishment led to less consistently applied social sanctions. Collectively this research, although it is experimental in nature, may prove useful when applied in public policy decisions seeking to improve free-rider problems within society.
Organizations such as the Red Cross, public radio and television or a volunteer fire department provide public goods to the majority at the expense of a minority who voluntarily participate or contribute funds. The same goes for projects that make use of Commons-based peer production. For example, contributions to online collaborative media like Wikipedia and other wiki projects, and free software projects such as Linux are another example of relatively few contributors providing a public good (information) freely to all readers or software users.
Proposed explanations for altruistic behavior include biological altruism and reciprocal altruism. For example, voluntary groups such as labor unions and charities often have a federated structure, probably in part because voluntary collaboration emerges more readily in smaller social groups than in large ones (e.g., see Dunbar's number).
While both biological and reciprocal altruism are observed in other animals, our species' complex social behaviors take these raw materials much farther. Philanthropy by wealthy individuals—some, such as Andrew Carnegie giving away their entire vast fortunes—have historically provided a multitude of public goods for others. One major impact was the Rockefeller Foundation's development of the "Green Revolution" hybrid grains that probably saved many millions of people from starvation in the 1970s.
Christian missionaries, who typically spend large parts of their lives in remote, often dangerous places, have had disproportionate impact compared with their numbers worldwide for centuries. Communist revolutionaries in the 20th century had similar dedication and outsized impacts. International relief organizations such as Doctors Without Borders, Save the Children and Amnesty International have benefited millions, while also occasionally costing workers their lives. For better and for worse, humans can conceive of, and sacrifice for, an almost infinite variety of causes in addition to their biological kin.
Voluntary altruistic organizations often motivate their members by encouraging deep-seated personal beliefs, whether religious or other (such as social justice or environmentalism) that are taken "on faith" more than proved by rational argument. When individuals resist temptations to free riding (e.g., stealing) because they hold these beliefs (or because they fear the disapproval of others who do), they provide others with public goods that might be difficult or impossible to "produce" by administrative coercion alone.
One proposed explanation for the ubiquity of religious belief in human societies is multi-level selection: altruists often lose out within groups, but groups with more altruists win. A group whose members believe a "practical reality" that motivates altruistic behavior may out-compete other groups whose members' perception of "factual reality" causes them to behave selfishly. A classic example is a soldier's willingness to fight for his tribe or country. Another example given in evolutionary biologist David Sloan Wilson's Darwin's Cathedral is the early Christian church under the late Roman Empire; because Roman society was highly individualistic, during frequent epidemics many of the sick died not of the diseases per se but for lack of basic nursing. Christians, who believed in an afterlife, were willing to nurse the sick despite the risks. Although the death rate among the nurses was high, the average Christian had a much better chance of surviving an epidemic than other Romans did, and the community prospered.
Religious and non-religious traditions and ideologies (such as nationalism and patriotism) are in full view when a society is in crisis and public goods such as defense are most needed. Wartime leaders invoke their God's protection and claim that their society's most hallowed traditions are at stake. For example, according to President Abraham Lincoln's Gettysburg Address during the American Civil War, the Union was fighting so "that government of the people, by the people, for the people, shall not perish from the earth". Such voluntary, if exaggerated, exhortations complement forcible measures—taxation and conscription—to motivate people to make sacrifices for their cause.
Altruism is the principle and moral practice of concern for happiness of other human beings or animals, resulting in a quality of life both material and spiritual. It is a traditional virtue in many cultures and a core aspect of various religious traditions and secular worldviews, though the concept of "others" toward whom concern should be directed can vary among cultures and religions. In an extreme case, altruism may become a synonym of selflessness, which is the opposite of selfishness.
Logrolling is the trading of favors, or quid pro quo, such as vote trading by legislative members to obtain passage of actions of interest to each legislative member. In organizational analysis, it refers to a practice in which different organizations promote each other's agendas, each in the expectation that the other will reciprocate. In an academic context, the Nuttall Encyclopedia describes logrolling as "mutual praise by authors of each other's work".
In economics, an externality is the cost or benefit that affects a third party who did not choose to incur that cost or benefit. Externalities often occur when the production or consumption of a product or service's private price equilibrium cannot reflect the true costs or benefits of that product or service for society as a whole. This causes the externality competitive equilibrium to not be a Pareto optimality.
In neoclassical economics, market failure is a situation in which the allocation of goods and services by a free market is not Pareto efficient, often leading to a net loss of economic value. Market failures can be viewed as scenarios where individuals' pursuit of pure self-interest leads to results that are not efficient– that can be improved upon from the societal point of view. The first known use of the term by economists was in 1958, but the concept has been traced back to the Victorian philosopher Henry Sidgwick. Market failures are often associated with public goods, time-inconsistent preferences, information asymmetries, non-competitive markets, principal–agent problems, or externalities.
In economics, a public good is a good that is both non-excludable and non-rivalrous, in that individuals cannot be excluded from use or could benefit from without paying for it, and where use by one individual does not reduce availability to others or the good can be used simultaneously by more than one person. This is in contrast to a common good such as wild fish stocks in the ocean, which is non-excludable but is rivalrous to a certain degree, as if too many fish are harvested, the stocks will be depleted.
In law and economics, the Coase theorem describes the economic efficiency of an economic allocation or outcome in the presence of externalities. The theorem states that if trade in an externality is possible and there are sufficiently low transaction costs, bargaining will lead to a Pareto efficient outcome regardless of the initial allocation of property. In practice, obstacles to bargaining or poorly defined property rights can prevent Coasean bargaining. This 'theorem' is commonly attributed to Nobel Memorial Prize in Economic Sciences winner Ronald Coase during his tenure at the London School of Economics, SUNY at Buffalo, University of Virginia, and University of Chicago.
A Pigovian tax is a tax on any market activity that generates negative externalities. The tax is intended to correct an undesirable or inefficient market outcome, and does so by being set equal to the external marginal cost of the negative externalities. Social cost include private cost and external cost. However, in the presence of negative externalities, the social cost of a market activity is not covered by the private cost of the activity. In such a case, the market outcome is not efficient and may lead to over-consumption of the product. Often-cited examples of such externalities are environmental pollution, and increased public healthcare costs associated with tobacco and sugary drink consumption.
Free-market environmentalism argues that the free market, property rights, and tort law provide the best means of preserving the environment, internalizing pollution costs, and conserving resources.
Social cost in neoclassical economics is the sum of the private costs resulting from a transaction and the costs imposed on the consumers as a consequence of being exposed to the transaction for which they are not compensated or charged. In other words, it is the sum of personal and external costs. Private costs refer to direct costs to the producer for producing the good or service. Social cost includes these private costs and the additional costs associated with the production of the good for which are not accounted for by the free market. Mathematically, social marginal cost is the sum of private marginal cost and the external costs. For example, when selling a glass of lemonade at a lemonade stand, the private costs involved in this transaction are the costs of the lemons and the sugar and the water that are ingredients to the lemonade, the opportunity cost of the labor to combine them into lemonade, as well as any transaction costs, such as walking to the stand. An example of marginal damages associated with social costs of driving includes wear and tear, congestion, and the decreased quality of life due to drunks driving or impatience, and many people displaced from their homes and localities due to construction work. In their simplest words it is the private cost+external cost.
The theory of the firm consists of a number of economic theories that explain and predict the nature of the firm, company, or corporation, including its existence, behaviour, structure, and relationship to the market.
The public goods game is a standard of experimental economics. In the basic game, subjects secretly choose how many of their private tokens to put into a public pot. The tokens in this pot are multiplied by a factor and this "public good" payoff is evenly divided among players. Each subject also keeps the tokens they do not contribute.
The Tiebout model, also known as Tiebout sorting, Tiebout migration, or Tiebout hypothesis, is a positive political theory model first described by economist Charles Tiebout in his article "A Pure Theory of Local Expenditures" (1956). The essence of the model is that there is in fact a non-political solution to the free rider problem in local governance. Specifically, competition across local jurisdictions places competitive pressures on the provision of local public goods such that these local governments are able to provide the optimal level of public goods.
A market is one of a composition of systems, institutions, procedures, social relations or infrastructures whereby parties engage in exchange. While parties may exchange goods and services by barter, most markets rely on sellers offering their goods or services in exchange for money from buyers. It can be said that a market is the process by which the prices of goods and services are established. Markets facilitate trade and enable the distribution and resource allocation in a society. Markets allow any trade-able item to be evaluated and priced. A market emerges more or less spontaneously or may be constructed deliberately by human interaction in order to enable the exchange of rights of services and goods. Markets generally supplant gift economies and are often held in place through rules and customs, such as a booth fee, competitive pricing, and source of goods for sale.
A missing market is a situation in microeconomics where a competitive market allowing the exchange of a commodity would be Pareto-efficient, but no such market exists.
A collective action problem or social dilemma is a situation in which all individuals would be better off cooperating but fail to do so because of conflicting interests between individuals that discourage joint action. The collective action problem has been addressed in political philosophy for centuries, but was most clearly established in 1965 in Mancur Olson's The Logic of Collective Action.
Reciprocity in evolutionary biology refers to mechanisms whereby the evolution of cooperative or altruistic behaviour may be favoured by the probability of future mutual interactions. A corollary is how a desire for revenge can harm the collective and therefore be naturally deselected.
Public economics is the study of government policy through the lens of economic efficiency and equity. Public economics builds on the theory of welfare economics and is ultimately used as a tool to improve social welfare.
The term private-collective model of innovation was coined by Eric von Hippel and Georg von Krogh in their 2003 publication in Organization Science. This innovation model represents a combination of the private investment model and the collective-action innovation model.
The collective action theory was first published by Mancur Olson in 1965. He argues that any group of individuals attempting to provide a public good has troubles to do so efficiently. On the one hand individuals have incentives to "free-ride" on the efforts of others in certain groups and on the other hand the size of a group is of high importance and difficult to optimally determine.
Warm-glow giving is an economic theory describing the emotional reward of giving to others. According to the original warm-glow model developed by James Andreoni, people experience a sense of joy and satisfaction for "doing their part" to help others. This satisfaction - or "warm glow" - represents the selfish pleasure derived from "doing good", regardless of the actual impact of one's generosity. Within the warm-glow framework, people may be "impurely altruistic", meaning they simultaneously maintain both altruistic and egoistic (selfish) motivations for giving. Whereas "pure altruists" are motivated solely by the desire to provide for a recipient, impure altruists are also motivated by the joy of giving. Importantly, warm glow is distinctly non-pecuniary, meaning it arises independent of the possibility of financial reward. Therefore, the warm glow phenomenon is distinct from reciprocal altruism, which may imply a direct financial incentive.