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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.

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