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The Economic Concept of Incentives: The Power That Moves People to Decision

People Respond to Incentives

What causes you to get up in the morning? Is it the blaring alarm clock you set the night before which eats into the peaceful serenity of your sleep? Is it the disappointed look on your father’s face as his long silhouette appears in the frame of your door holding a belt? Is it the panic inducing urgency to do something meaningful with your life before the inevitable decay of your cognitive capabilities? Every one of our actions is done for a reason, a reason determined by our individual human nature, and acted upon by virtue of our personal agency. No matter how crucial or how trivial someone may decide your reasons to be, they serve as the motivation behind each of your actions whether you realize it or not. Economists know these reasons as incentives.

Examples of Incentives

People respond to incentives of all kinds, and incentives can be as large or as small as they need to be. For instance, Tommy decides one day that he wishes to purchase a house. This is not a spontaneous decision. There are underline reasons why he wishes to make this change. In this case, Tommy believes that a house would be a more stable setting for him to raise his family. He believes a house to be a good financial investment. He believes that a house would make for a much more comfortable living environment. All these are incentives for Tommy to purchase a house. A house that meets the conditions Tommy has laid forth will motivate Tommy to purchase it more than a house that does not.

This concept may seem obvious, but to understand the mind of an economist, you must see the incentive behind every decision. Later, Tommy walks into a thrift shop and finds a Tungsten cube no larger than a thimble and purchases it for $100. Like the house, this was not a spontaneous decision. Tommy was incentivized by the cube’s weight, which he personally found compelling. It is not the job of an economist or the intent of this article to explain "why" someone might be incentivized to do something. Rather, it is the job of an economist to understand "what" incentivizes people. Every single decision no matter how small is caused by an incentive. And if you know what causes someone to act, then you can predict what they will do.

Incentives in Economics

As stated above, an economist is not so concerned with why someone responds to an incentive so much as what incentives they respond to. Money for instance is a large motivator for many people. Furthermore, people only seek money because they are incentivized by other things. TVs, Cars, Houses, Cheetos are all incentives driving people to operate in the economy. An economist will have many reasons to be interested in this.

Macroeconomists want to see what large populations are motivated by so that they can make major predictions about the economy at large. Knowing what motivates people to spend and make money is crucial to making large decisions that affect these people’s everyday lives. Tax decisions, for instance, are highly dependent on knowing what people like to purchase most, and then predicting how much they will still want to buy if its price increases. Microeconomists work on the business side of things, and similarly want to know what incentivizes people so they can know what to sell, where to sell it, and how much they can charge.

Incentives end up being a crucial aspect of the economy because they are directly concerned with human behavior. Some have gone as far as to call economics the study of incentives.

Incentives: Key Takeaways

What’s important to take away is that incentives motivate everyone’s actions, including your own. Next time you want to buy something, thoroughly determine the reasons motivating that desire. Next, begin to determine what makes other people make their decisions. When you begin to see every person as a grocery list of incentives, you’ll be thinking like an economist.

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