Next video:
Loading the player...

In economics, the free rider problem refers to someone being able to get, for less or even for free, what others pay more for. The problem comes when individuals are unwilling to pay their fair share for something that most others pay for. This is most prevalent when talking about public goods.

Most of the common goods subject to a free rider problem have two characteristics that make them susceptible. First, the good is non-excludible, meaning that once it is provided it can’t be allocated among people who pay and people who don’t – anyone can use it. The second is that use of the good doesn’t reduce the amount others may receive. Therefore, there is less incentive to prohibit non-payers from receiving the goods or services.   

For instance, a government is charged with defending its citizens.  Once it provides for defense, there is no way to allocate this service between taxpayers and tax evaders. They both get defended. In addition, the amount of defense is not reduced because the tax evader was defended in addition to all the taxpayers who were also defended. 

In the investment world, the free rider problem refers to a brokerage firm client who purchases a financial instrument without paying for it, then quickly sells the security for a profit. Often this occurs because the client used unsettled funds to make a trade. This is a violation of Federal Reserve Board Regulation T and can result in a brokerage account being frozen for 90 days.

Related Articles
  1. Insurance

    Let Life Insurance Riders Drive Your Coverage

    Find out how these additional benefits can help you customize your policy.
  2. Financial Advisor

    How Accelerated Benefit Riders Fill Insurance Gaps

    Accelerated benefit riders have become the new darlings in the financial marketplace. Here's why.
  3. Financial Advisor

    A Closer Look At Accelerated Benefit Riders

    Accelerated benefit riders can allow policy holders to access the death benefit in their life insurance policy while they are still living if they meet certain conditions. Knowing what you get ...
  4. Financial Advisor

    Should You Buy A Life Insurance Disability Rider?

    Does it make sense to pay an additional cost for a waiver of premium rider on a life insurance policy?
  5. Retirement

    Variable Annuities with Guaranteed Benefit Options

    Guaranteed benefit riders protect variable annuities against a market downturn, but they also make an already expensive product even costlier.
  6. Investing

    Public Goods & Free Riders

    A public good is an item whose consumption is determined by society, not individual consumers.
  7. Financial Advisor

    Long-Term Care: How Medicaid Stacks Up

    Clients who think Medicaid is a good option for long-term care usually don't know the rules that come with the process of applying for it.
  8. Retirement

    Variable Annuity Benefits: What The Fine Print Won't Tell You

    Learn the truth before you strap yourself into these annuity "seat belts".
  9. Small Business

    4 Reasons Why Riders Choose Uber

    Find out the reasons why riders love Uber, which has provided more than 1 billion rides to customers worldwide.
Hot Definitions
  1. Two And Twenty

    A type of compensation structure that hedge fund managers typically employ in which part of compensation is performance based. ...
  2. Market Capitalization

    The total dollar market value of all of a company's outstanding shares. Market capitalization is calculated by multiplying ...
  3. Expense Ratio

    A measure of what it costs an investment company to operate a mutual fund. An expense ratio is determined through an annual ...
  4. Mezzanine Financing

    A hybrid of debt and equity financing that is typically used to finance the expansion of existing companies. Mezzanine financing ...
  5. Long Run

    A period of time in which all factors of production and costs are variable. In the long run, firms are able to adjust all ...
  6. Quasi Contract

    A legal agreement created by the courts between two parties who did not have a previous obligation to each other. A normal ...
Trading Center