Free Rider Problem

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DEFINITION of 'Free Rider Problem'

1. In economics, the free rider problem refers to a situation where some individuals in a population either consume more than their fair share of a common resource, or pay less than their fair share of the cost of a common resource.

2. In the context of a brokerage firm, a free rider problem refers to a situation where a client has been allowed to purchase shares without actually paying for them, and then subsequently sells the shares (ideally for profit).

BREAKING DOWN 'Free Rider Problem'

1. A commonly used example of the economic notion of the free rider problem is found in national defense. All citizens of a country benefit from being defended; however, individuals who evade taxes are still protected by the same common resource of national defense, even though they did not pay for their fair share of the resource.

2. The problem with this scenario is that the client, if allowed to free ride, can profit from a stock trade without actually using any of his or her own capital. This is illegal.

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