In this subsection we analyze alternative institutions for deciding on the provision and financing of the public good. The conventional experiment conducted to analyze decision making in the presence of public goods is the Voluntary Contribution Mechanism (VCM). It gives some insight to the question why are the public goods commonly provided by government, rather than private firms.

Within the VCM game individuals are given an endowment of tokens and they must decide how many tokens they wish to contribute toward the provision of the public good. Their payoff in the VCM game is determined as follows:

Payoff(i) = a*E(i) - c(i) + (b/N)*(Total Contributions)

where a is the return per a token retained by the individual, E(i) is the endowment given to subject i, c(i) is subject i's contribution toward the public good, (b/N) is the portion of the total contributions made toward the public good that subject i recieves back, with Total Contributions being the sum of all the contributions. To analyze the presence of "free riding," the [LINKunderrevalation of demand], it is often assumed that a < b, but that it is Pareto Optimal for everyone to contribute their entire endowment because [(b/N)*(Total Contributions = Total Endowments)] > a.

For an illustration, suppose the following experimental scenario:

There are 4 participants in one group. Each participant is endowed with $20 and each one of them can contribute between 0 and 20 dollars toward the public good. The money not cinvested in the public good are retained by each individual. For every dollar contributed each of the four group members, no matter how much they contributed, earned $0.4. Thus, the individual return from $1 on non investing (keeping the money) is equal to $1, return on investing is equal to $0.4, but the group return on investing is $1.6. It is easy to see that it is always a dominant strategy not to invest and keep all the money, no matter how much the other members of the group contributed. Yet, if all subjects retain their endowments they earn $20 each (Nash equilibrium outcome), whereas if all of them invested everything, they earn $32 each (Pareto efficient outcome.)

Notice that if a subject believes that everyone else will contribute their endowments they have an incentive to free ride on the other subjects by retaining their own endowment and obtaining the return on the other subject's contributions. Since everybody reasons in similar manner it yields an under-provision of the public good.

Using the VCM mechanism it has been shown that when one increases the group size participating in the experiment the amount of "free riding" increases. In addition,a reduction in the marginal return from contributing to the public good will also increase the amount of "free riding" present (Isaac and Walker, 1988). For more interesting experimental findings using the VCM mechanism go to Experimental Research on Public Goods subsection.

Charles Holt and Susan Laury have created a simple VCM game that can be implemented within the classroom to illustrate the presence of "free riding" (Holt and Laury, 1997.) To conduct this experiment in class see the instructions titled, 'Classroom VCM Game' in the Classroom Experiments on Public Goods section or in the online resources option.

For a computerized version of the Voluntary Contributions Mechanism game go to Charles Holt?s VCM software.