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Free Riding

Free riding occurs when individuals or entities benefit from resources, goods, or services without paying for them, relying on others to bear the costs. This behavior is common in public goods, like national defense, where non-payers cannot be excluded from enjoying the benefits. In financial markets, free riding can refer to trading without adequate funds, relying on unsettled trades to cover obligations. Free riding can lead to inefficiencies and reduced incentives for others to contribute.

Example

An investor buys shares using proceeds from a sale that has not yet settled, engaging in free riding, which is prohibited by most trading regulations to prevent market abuse.

Key points

• Involves benefiting from goods or services without contributing to their cost.

• Common in public goods and financial markets.

• Creates inefficiencies and reduces incentives for others to participate or pay.

Quick Answers to Curious Questions

It leads to underfunding and potential underprovision of essential services, as individuals rely on others to cover costs, diminishing overall efficiency.

Regulations prevent free riding by requiring traders to have sufficient funds before trading, maintaining market integrity and fairness.

Free riding reduces incentives for investment and participation, leading to suboptimal provision of goods and services, affecting overall economic welfare.