How Insurance Works

The Free Rider Problem – Strata Academics

Imagine a town with bodies of standing water…and
everything that standing water brings, including mosquitos. Lots of mosquitos. Now a reasonable mosquito controller might
believe that people will pay him to spray and kill the adult and larval pests. But if he sprays and then seeks payment from
his potential customers–the people in town who prefer to have fewer mosquitos–he will
actually face a free rider problem. What is a free rider problem? It is some people not paying their way for
a product that all prefer–such as controlling mosquitoes. Once the mosquitos are sprayed, everyone benefits,
whether they paid or not. So each person ends up thinking, “Why should
I pay at all?” Because the benefits of a mosquito abatement
are received upon production, not upon payment, people can benefit without paying. They get a free ride because benefits are
socialized while costs are privatized. Free riders are especially a problem with
what are known as public goods. In our example, the public good at question
is mosquito control. A purely public good has two main characteristics: 1. It is non-excludable, meaning the benefits
of the good (the consumption) can’t be confined to a specific group of payers or subscribers. 2. A public good is also non-rivalrous, a fancy
way of saying that one person’s consumption of a good does not affect another’s consumption. You’re consuming the reduced number of mosquitoes as am I for example. These aspects of a public good make it difficult
for entrepreneurs, like our mosquito controller, to turn a profit. Government’s answer to free riding is to
turn free riders into forced payers through taxation. Many towns in the United States have government
imposed mosquito abatement programs funded through forced taxation. But taxation doesn’t solve all the problems. In fact, it raises more difficult questions
of pricing and supply. How much is mosquito control is enough? How do you quantify the different value various
citizens place on mosquito population numbers? Who should pay, and how much? Should we use a flat tax, or tax people who
live closer to the wetlands at a higher rate than people who live in areas with fewer mosquitos? How should payments be made? Since price tags are not found on how much
mosquito abatement an individual consumes, tax systems are at best a guess about how
much to charge. Since people can free ride, there is a powerful
incentive to offer nothing or little in exchange for a public good. As bad as that is, the assumption that forced
taxation is the only way to solve public good problems causes even more problems. No matter how we try to solve collective problems, such as public goods problems,
we are very likely to introduce any number of complicating factors into the mix. Turns out, there are no perfect answers, only tradeoffs.

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