Experimental evidence on the free rider problem

0. Index

1. General Introduction

2. Introduction to free-riding experiments
2.1. Experimental design
2.2. The Voluntary Contribution Mechanism
2.3. “Contradictional effects”
a. Public good is not “pure”
b. Unknown group optimum / payoff
c. Misunderstanding
d. Uncertainty
e. Insufficient economic incentive
f. Small groups
g. Interactions
2.4. Explaining different Experimental results
2.4.1. Altruism and Warm Glow
2.4.2. Framing
2.4.3. Influence of MPCR and Group Size
2.4.4. Learning
2.4.5. Communication

3. Conclusions

4. References

5. Appendix

1. General Introduction

US individuals made over 100 billion dollars of philanthropic contributions in 1995.^[1] This depicts a contradiction to the traditional utility theory, in which each individual cares just for itself. This behavior is explained by altruism and other not rational or monetary theories. “A fundamental debate in the literature on public goods provision is on the applicability of the so-called 'free-rider' hypothesis.^[2] Although there exists no single universally accepted definition of 'free riding', ideas of misrevelation of demand and of subsequent suboptimal provision of public goods have been a standard part of the literature on public goods for at least 30 years.”^[3]

There exist slightly different definitions for that issue, but with a free ride is meant when a person takes advantage or enjoys benefits from a good, namely a public good, without contributing anything for consuming or using it and finally benefiting from it. The Free-Rider-Problem is closely connected with the theory of public goods. There exist two basic types of goods, private and public ones. The former is characterized through a market where goods can be traded. There exist a link between producing, financing and using a private good. As consumer pay money for receiving a book or an apple, she or he is signalling the producer that the product is worth to buy for this certain amount of money. If there is competition and there doesn’t exist market dominance, price mechanism will create a market equilibrium. This outcome is efficient. Let us simplify this with an example. If someone buys an apple, she and just she enjoys the benefits from eating it. With other words this private good is exclusively used because no one else can consume it and receives an advantage. In contrast to private goods individuals cannot be excluded from consuming a public good, or up to a certain extent it is difficult or costly to operate a system of charges that denies access. An example might be television transmission. Consider German public television, no one can be excluded whether someone pays charges or not to the “GEZ”. “And second characteristic of a public good is the non-rivality in consumption, if someone benefits from public goods does not reduce the ability of others to enjoy it. With regard to our example quality of television transmission is independently whether thousand or a million people watch TV at the same time. Other examples for public goods are coast protection, public lighting, national defense, waterways and other. This inability to exclude individuals that do not pay anything for the public good, they can take a free ride. There is obviously a problem, that there is a service provided that is combined with costs for producing it, but on the other hand individuals receive benefits without paying for it. Therefore experiments may help to solve such problems in reality while figure out, which worth a public good has in the eye of the consumer. Firstly there should be set right the distinction between private and public goods.

In the following part the problem public good will be explained by a quite easy example.^[4] Individuals have preferences and demands for public as like for private goods. There is a demand for public lighting, national defense, parks as like for shoes, cars or houses on the private market. If price for oranges is low they demand more as they do for a public good. The price for shoes demanded can be observed, price for coast protection not. This lack of information leads to failures in the market of a public good. We may assume that the price for each unit of the public goods is the constant tax price T for each coast guard demanded. The difference between private and public good is that the provision has to be realized by a collective action and aggregate demand curve differs from private ones. The demand curve for a public good are added vertically e.g. for a given quantity.^[5] Each individual has to consume the same amount of coast guards, independently personal preferences would be less or more. Assuming the easiest case of a small society of two individuals consuming this public good with identical preferences. Suppose both place a marginal benefit of Abbildung in dieser Leseprobe nicht enthalten, so that in this economy the aggregated marginal evaluation for the fixed amount of coast guards is Abbildung in dieser Leseprobe nicht enthalten. To reach the social optimum the marginal benefits Abbildung in dieser Leseprobe nicht enthalten should equal the marginal costsAbbildung in dieser Leseprobe nicht enthalten. If marginal benefits of last provided unit of public good are greater (lower) then the marginal costs, means more (less) units should be provided. In this case the optimal amount of coast guards for this two person society is five because optimality criterion Abbildung in dieser Leseprobe nicht enthalten is fulfilled. But finally aggregate condition is relevant for efficiency, so marginal tax by each individual should be equal to the marginal benefits for each one, but personal preferences cannot be revealed. To evaluate the benefits of all consumer and their different attitudes for security is impossible. Therefore experiments seem to be a good remedy to determine individuals preferences for providing a public good and to explain the free-rider problem more precisely. “Economic theorists have reacted to the free riding problem by designing sophisticated mechanisms for the implementation of an efficient allocation of public goods (e.g. Clarke 1971, Groves 1973, Groves and Ledyard 1977, Green and Laffont 1979, for a survey see Laffont 1987)”.^[6]

2. Introduction to free-riding experiments

“Free riding incentives are a pervasive phenomenon of social life” as mentioned in a paper of Falkinger, et al., (2000) may describe the occurrence of free riding quite strong but applicable.

While contemplating different experimental studies someone realizes that evidence for free-riding behavior is quite strong varying. Like Bohm (1972), who refused it nearly completely or at least did not found any evidence for free riding. Two other experimental papers, Sweeny (1973) and Marwell & Ames (1977), provide evidence for only a weak version of free riding hypothesis while others Andreoni (1988), Isaac, Walker, Williams (1994), Smith (1980) support the free-rider theory up to a certain extent.

As we have seen the differences between private and public goods in former chapter a company wouldn’t be successful at the market because individuals know that they can’t be excluded from enjoying the benefits whether they buy it or not. An experimental solution might be the voluntary contribution mechanism in which each individual pays that amount of money willing to add depending on their own “utility” for the public good. But rational consumer would argue that she or he will receive benefits whether contributing for provision or not. To consider and solve such problems economist often use game theory. Generally there are two different types of playing a game a cooperative and a non-cooperative one while this former one often occur in connection with theory of clubs that represent “voluntary formed coalitions”^[7] and members are free to decide whether to stay in the club and pay fees or to leave it. More relevant to externalities is the non-cooperative behavior, in which individuals seek to maximize their own utility not contemplating effects on optimality for the group. A classic example for this phenomena is the prisoner’s dilemma formulated by A.W. Tucker during the 1950s. This game is a non-cooperative one because it’s not possible to make a binding agreement. That theory explains the decision of two people (A and B) accused of committed of crime. The question for both is how to respond or act.^[8] Each player has the choice between “confess” or “don’t confess.” For A it is better to confess when B has chosen to confess because a sentence of eight is better then ten years. Best response for A to B’s decision “don’t confess”. A will minimize the sentence by confessing because 3 month are better than a year. Hence, the dominant strategy for A is to confess, independently what B does. Thus, both player will end at solution “confess/confess” and each gets eight years, even if “don’t confess” would have been better, means seven years less in jail.

The prisoner’s dilemma analysis has been applied to many decision making environments, including the financing of a public good through voluntary contribution. Let us consider a practical case that a public good should be provided through voluntary contribution mechanism.^[9] Imagine there is a society of 1000 person and a threshold of $10000 is needed that is necessary to provide the public good, otherwise the public good won’t be provided.^[10] So every individual has to contribute $10 to achieve the needed amount of money. Assume that the public good creates a utility of $30 for each person. From each individuals perspective, like A’s, is better off paying nothing if the others contribute zero because 0 is better than –$10. If all except A pays her or his contribution of $10 A is better off when paying nothing because the public good will be provided and utility is $30 instead of $20. Finally each decider has the perspective of A from single point of view or each individual’s the best strategy is not to contribute with the result that the public good will not be provided and there is no utility increase. Finally the sub optimum solution in right down corner will be reached.^[11]

2.1. Experimental design

“Large literatures in both psychology and economics have emerged investigating the public goods problem (Ledyard, 1996). A common method used in the controlled setting of the laboratory is the voluntary contribution mechanism” (VCM).^[12]

Next to the VCM there are other methods to solve the free-riding problem investigated by Smith (1979a). He compared three public goods mechanisms under the condition of no income effects. Firstly he investigated the Groves-Ledyard quadratic cost allocation Mechanism, secondly The Auction Mechanism and finally the third one an incentive incompatible Lindahl mechanism. These mechanisms are recommended for more experienced/interested reader of this topic. This paper is concentrated on VCM.

The following chapter will analyze how does the voluntary contribution mechanism works and why there is dominant strategy to free ride.

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^[1] Giving USA, Kaplan, Ann E. (ed.) New York, NY: American Association of Funding Counsel (1996)

^[2] Cornes and Sandler (1996) describe this occurrence of free riding as easy-riding in that sense that individuals not entirely free-ride as some experimenters define free-riding behavior occurs when less than a third is contributed to group account respectively to the public good.

^[3] See Isaac, Walker, Thomas (1984), p. 116.

^[4] Compare Johnson (1991), pp. 113 ff.

^[5] See appendix, figure 1 and 2, p. 19.

^[6] Compare Falkinger, et al., (2000), p. 4.

^[7] See Cornes/Sandler (1996) , p. 18.

^[8] See appendix, figure 3, p. 20.

^[9] This is an extract of Johnson’s example, comp. Johnson (1991), p. 112 f.

^[10] Schneider and Pommerehne (1981) have investigated in a quite similar experiment with students from Switzerland contributing for a new book facilitating preparation for coming exam.

^[11] See appendix, figure 4, p. 20.

^[12] Kurzban (2001), p. 242.