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Economic Incentives and People’s Response

Introduction

One of the most important issues studied by macroeconomics is the decision-making process and motivation, where economic incentives play an essential role. In business, policy-making, and different kinds of economic relations, incentives are believed to define people’s behavior and induce a particular reaction. Since incentives serve as the trigger for people’s decisions, many economists study the principles of their influence on human behavior in order to ensure the stability of the national economy. Some researchers suggest that people react to incentives in a particular and often predictable way, which may help companies and government define their economic policy. At the same time, other economists argue that not all incentives lead to an increase in certain behavior, but, on the contrary, may induce an adverse response. In this essay, these ideas are analyzed from the point of view of macroeconomics to define the most common reactions of people to economic incentives.

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Main body

First, it is necessary to consider the general role of incentives in economics. Sexton (2018) emphasizes that economic incentives are used to encourage specific behavior of people, or, on the contrary, discourage them from certain actions. He states that a response to an incentive is dictated by the natural desire of people to derive a benefit. In particular, it is a result of comparing the expected marginal benefits with expected marginal costs (Sexton, 2018). At the national level, the government of the country may control the behavior of citizens by decreasing or increasing taxes, prices, subsidiaries, and wages (Sexton, 2018). Besides the economy, in everyday life, people’s actions are also defined by the rewards and punishments; similarly, reaction to economic triggers complies with the general principles of human psychology. In this paper, people’s responses to the economic incentives of different nature are discussed in detail.

The most widespread typology of economic triggers includes positive and negative incentives. According to Sexton (2018), positive incentives imply increasing benefits and reducing costs, which, in turn, leads to an increase in related activity or behavior. Negative incentives, on the contrary, include increasing costs or reducing benefits. They lead to a decrease in related activity or behavior, since an individual sees the disadvantages of these changes. For example, increased cost for automobiles with a high level of pollution, which is a negative incentive, discourages the use of such cars and positively influences the environment (Sexton, 2018). Therefore, from the point of view of macroeconomics, positive and negative incentives may be used for significant, nation-wide changes.

One of the widespread opinions about human behavior and response to incentives is that they can be repetitive. The predictable nature of incentives is closely connected to psychology. This idea lies at the foundation of entire science – behavioral economics, which focuses on the psychological, cognitive, and other factors of decision-making. Economists study the effects of incentives to predict possible outcomes of introducing new policies of other changes at the national level. Sexton (2018) agrees that since people tend to look for better opportunities and the sources of benefit, the change in incentives may cause predictable reactions. The researcher demonstrates this idea on the example of increasing salaries for different professions and suggests that people would rather work in a more profitable sphere. He encourages policymakers to evaluate incentives and their possible consequences carefully and warns that poor policy-making may have a reverse effect on people’s behavior. For example, a sharp increase in taxes may lead to a decline in the domestic market (Sexton, 2018). Therefore, policymakers need to look at changes from the perspective of citizens and their expected benefits.

The direct correlation between the reward and an increase in certain behavior is considered a standard theory. According to Strang et al. (2016), the most widespread opinion is that “higher incentives lead to higher effort” (p. 285). For example, a company may offer financial bonuses to its employees for a good performance, which is likely to encourage them for productive work. However, the authors suggest that even positive incentives may discourage people from certain action or behavior. Intrinsic and extrinsic motivation are essential terms explaining this idea. According to Deci, “one is said to be intrinsically motivated to perform an activity when he receives no apparent rewards except the activity itself” (as cited in Strang et al., 2016, p. 288). Moreover, particular studies demonstrate that monetary incentives positively influence the performance quantity, rather than performance quality. Besides, small rewards may decrease performance in comparison to no reward at all (Strang et al., 2016). Therefore, people’s response to an economic incentive may depend on the value of the incentive.

Even though the findings mentioned above prove the ambiguous effect of incentives, in most cases, they do have a positive influence on people’s behavior. Strang et al. (2016) conclude that if the incentive is closely connected to the particular performance or task, people are more likely to become motivated. It is also important to distinguish monetary and non-monetary incentives. According to Strang et al. (2016), non-monetary rewards that reflect ability, such as positive verbal feedbacks, are perceived as emphasizing competence and lead to an increase in intrinsic motivation. Moreover, the authors state that monetary rewards can be described as “controlling one’s behavior and, thereby, reducing perceived autonomy and decreasing intrinsic motivation” (Strang et al., 2016, p. 290). This idea can be applied to macroeconomics since governments also use moral suasion and other non-monetary incentives.

The idea about intrinsic and extrinsic motivation and its connection to economic incentives is widely supported in the field of economy. According to Ito et al. (2018), the central issue of economy and policy-making is “whether appealing to intrinsic and extrinsic motivations can generate persistent effects on economic activities” (p. 240). The study conducted by the researchers demonstrates three major responses to economic incentives. Habituation implies that “repeated presentation of a stimulus might cause a decrease in reaction to the stimulus” (Ito et al., 2018, p. 244). According to this theory, people tend to have a clearly defined increase in certain behavior after the first introduction of a stimulus. However, if the same incentive is repeated, there is a high chance of a decrease in response. The opposite theory, sensitization, implies that repeated incentive induces an increase in the response activity. Ito et al. (2018) support the idea of Sexton (2018) about the challenges of policy-making. Since economic policies are generally implemented repeatedly, it is difficult to predict whether they will cause an increase or a decrease in response.

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Another type of reaction induced by economic stimuli can be referred to as dishabituation. According to this idea, a new type of incentive or a stronger or weaker intensity of the incentive may result in declined responses. Finally, habit formation implies that “a short-run intervention might form a habit of consumption for the future” (Ito et al., 2018, p. 244). This theory means that the effects of the incentive intervention may continue even after the final incentive. To summarize, the discussed scientific terms demonstrate the variety of people’s responses to incentives and the connection of the issue to human psychology.

It is possible to make the following conclusions about how people respond to economic incentives. First, the question whether the reaction of people to economic triggers is predictable does not have a definite answer. Generally, positive incentives lead to an increase in a particular action, while negative incentives result in the opposite reaction. At the same time, human behavior is also defined by the type of incentive, its relation to the specific task or activity, and the length of the period, during which the stimulus was implemented. For example, as it was demonstrated in some of the studies discussed above, relatively small monetary rewards and repetitive awards may induce a decrease in the performance. To conclude, people’s responses to incentives differ depending on the situation and incentives themselves.

Conclusion

In macroeconomics, understanding the most common responses to incentives is especially important, since this area of economy deals with issues at the national level. For successful policy-making, governments and companies need to consider all possible factors that may influence the effect of the intervention. What is more, irrelevant incentives may result in reverse reaction, and consequently, lead to economic instability. Therefore, the psychology of human behavior, the main principles of decision-making, and the compliance of the incentives with people’s expectations are necessary to induce the intended response.

References

Ito, K., Ida, T., & Tanaka, M. (2018). Moral suasion and economic incentives: Field experimental evidence from energy demand. American Economic Journal: Economic Policy, 10(1), 240–267. Web.

Sexton, R.L. (2018). Exploring macroeconomics (8th ed.). SAGE Publications.

Strang, S., Park, S. Q., Strombach, T., & Kenning, P. (2016). Applied Economics: The use of monetary incentives to modulate behavior. Progress in Brain Research, 229, 285–301. Web.

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