What Motivates Us?
Prof. Mario Villarreal-Diaz claims that incentives matter, especially in a world of scarcity. Market prices, for instance, are a very powerful incentive. When the price of a good rises, consumers look for substitutes or ways to economize. Producers, on the other hand, look to increase output. When the price of a good falls, consumers will purchase more of it and producers will look for ways to cut back production.
- Incentives Matter [Article]: Russell Roberts, through the example of prisoner transportation, shows how a change in incentives reduced prisoner mortality rates from 12 percent to far less than 1 percent.
- Incentives for Immoral Behavior [Video]: Milton Friedman explains how government regulation often incentivizes, and therefore brings about, immoral behavior.
- Always Think of Incentives [Article]: Stephen Davies argues that in order to understand human behavior, one must understand incentives.
- Property Rights [Article]: Karol Boudreaux explains the vital role property rights play in promoting growth, alleviating poverty and conserving scarce resources (found on pp. 47-55).
- Welfare [Video]: Thomas Sowell explains how government welfare programs incentivize undesirable outcomes.
What Motivates Us?
We economists try to understand how individuals make choices. In doing that, we have several tools and basic principles to see the world. One of the most important ones is observation that individuals react to incentives. And when reacting to incentives, they adjust their behavior accordingly. And that's true when an individual is trying to make a choice, especially when they face constraints, such as limited resources, limited time, different wants and needs, and other kinds of things.
A classic example of the incentives matter principle is the price system. If the price of something goes up, you will buy less of it, or you will tend to buy less of it. If the price of something goes down, you will tend to buy more of it. And if you don’t like something it doesn’t matter how much it costs, you simply don’t care about it. But, if you're already buying something, if that product is part of your normal consumption and the price of that changes, you' will adjust your behavior accordingly. Let's say that you like coffee, and the price of coffee goes up. And you also like tea. Probably you'll tend to replace coffee with tea because it’s cheaper and you will get the same satisfaction of that consumption.
In a market economy, prices are signals that convey some valuable information for both consumers and producers. Think about a producer of furniture. If the price of wood goes up, that tells the producer something about their business. Probably, he or she will try to replace that raw material for a cheaper one, or the price will increase, or they will try to make their production process more efficient in order to adjust to that signal that the price is sending to them. So they react to the incentive that the price system is setting.
Monetary incentives are not the only ones that matter. We economists tend to focus more on monetary incentives because they are easier to observe. But, there are a whole bunch of nonmonetary incentives that are really important. People care about reputation, people care about love, people care about their time, and of course those incentives also affect their behavior. Those things also affect the incentive structure that surrounds the environment within the individual makes choices. For example, if you want your wife to wash dishes, probably it’s not a very good idea to offer her 10 bucks.
Probably your spouse will respond better to other types of incentives, like caring about her, or him taking care of the house or kids or what have you, right? It is hard to measure how incentives will impact behavior. We can have a sense of which way the individual will move in their choices when facing incentives. But, that's an important observation, like what is important for me might not be important for someone else in my incentive structure. There’s people that care more about reputation than others. Criminals, I doubt that they care about their reputation with society. Probably they care about their reputation with their fellow criminals, like being tough or being ruthless. But, what I'm trying to say is that different individuals will react in a different way facing the same incentive. So incentives are very context specific. Think about if the price of oranges goes up. Probably somebody likes oranges so much that it will not matter; they will still buy the same amount of oranges. But for someone that don’t care a lot about oranges, they will probably try to substitute by buying apples. The same incentive—price of oranges goes up—can have different effects on choices for different individuals. Sometimes we make the mistake to think that incentives will work the same for everybody, and that's not the case.
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