Question

How are the free rider problem and the common pool resource problem related to basic problems of externalities?

Short answer

Both problems involve externalities: the free rider problem causes under-provision (negative externality), and the common pool resource problem leads to overuse (negative externality).

Step-by-step solution

Understand Externalities

Externalities occur when a person's actions have an effect on a third party who did not choose to be involved in the interaction. They can be either positive or negative, depending on whether they result in benefits or costs. Basic problems of externalities include inefficiencies and market failures that arise because external costs or benefits are not reflected in market prices.

Define Free Rider Problem

The free rider problem refers to a situation where people can enjoy the benefits of a public good or service without paying for it or contributing to its cost. This arises because public goods are non-excludable and non-rivalrous, meaning one person’s use does not reduce availability to others, and people cannot be prevented from accessing them.

Identify the Common Pool Resource Problem

Common pool resources are resources that are non-excludable but rivalrous, like fisheries, forests, or grazing land. The problem here is that individuals using the resource often act in their self-interest and overuse it, leading to depletion, which affects others who also depend on the resource.

Link to Externalities

Both the free rider problem and the common pool resource problem involve externalities. In the free rider situation, the inability to provide adequate funding for public goods leads to under-provision, a form of negative externality. Meanwhile, in common pool resources, overuse and depletion introduce negative externalities, as costs are imposed on others who use the resource.

Key concepts

Free Rider Problem

The free rider problem is a major issue in economics that occurs when people benefit from resources, goods, or services without paying for them. This often happens with public goods, which are non-excludable and non-rivalrous. Non-excludable means you can't prevent someone from using the good, and non-rivalrous means one person's use doesn't reduce its availability to others.

Consider a public park. Everyone can enjoy the park, whether or not they contribute to its upkeep. If too many people decide not to contribute, the park may become poorly maintained.

The problem here is that individuals do not have an incentive to pay if they believe others will cover the cost. This leads to underfunding. Consequently, this problem is tightly bound to the notion of externalities because, when funding and maintenance are inadequate, negative externalities—like a dirty or unusable park—impact all users.

Common Pool Resources

Common pool resources are unique types of goods that are non-excludable but rivalrous. This means that, while anyone can access them, one person's use diminishes their availability for others. Classic examples include fisheries, forests, and grazing lands.

Because these resources are open to all, they can become subject to overuse. Each person tries to maximize their benefit, often ignoring the long-term consequences for others. This is known as the "tragedy of the commons."

When individuals act in their own self-interest without considering the depletion of the resource, this leads to negative externalities. Here, the external costs are overexploitation and eventual exhaustion, affecting the community that depends on the resource.

Market Failures

Market failures occur when the allocation of goods and resources by a free market is not efficient. There are several types of market failures, but they often relate closely to externalities.

For instance, the presence of external costs or benefits not captured in market transactions leads to inefficiencies. The overuse of a common pool resource without compensating those affected is one such market failure. Similarly, the under-provision of public goods due to the free rider problem represents another form.

• Externalities: Encourage scenarios where individual actions have unaccounted impacts on others.
• Public Goods and Common Pool Resources: Challenge efficient market outcomes due to their non-excludable nature.

Market failures prompt the need for interventions like taxation, subsidies, or regulations to correct inefficient outcomes and address the resulting externalities effectively.