Economic Incentives: Definition, Examples & Quiz
What motivates people to work or start a business? In this lesson, you'll learn about economic incentives, related concepts and be provided some examples along the way. You'll also have a chance to reinforce your knowledge with a short quiz.
Economic incentives are what motivates you to behave in a certain way. Preferences are your needs, wants and desires. Economic incentives provide the motivation to pursue your preferences. Let's look at a basic example. Let's say you want wealth. You are motivated to work because you will be paid, which will help you achieve your preference for accumulating wealth. Of course, economic disincentives discourage behavior. Taxes are a prime example of disincentives because they make products and services more expensive.
Intrinsic Incentives and Extrinsic Incentives
Extrinsic incentives come from outside of a person. These are the typical economic incentives that you probably think about all of the time. Extrinsic incentives include cash rewards, bonuses, income, and profits. However, it's not all about money. External incentives can include such things as peer recognition, fame, social status and power. Some of these incentives will work better than others depending upon your preferences. Someone may care more about social status, for example, than money.
Intrinsic incentives are psychological incentives and are internal to the person. Getting satisfaction from work is an intrinsic incentive. The feeling of making a difference in the world is also an intrinsic motivation - regardless of whether you actually make a difference or not. Sometimes extrinsic motivations will trump intrinsic motivations. For example, the idea of building a home for the poor makes you feel good, but you will gladly accept pay to do it, which ends your spirit of volunteering.
Keep in mind that extrinsic and intrinsic incentives are not mutually exclusive. They can work together. For example, you may not care much about money, but you do tend to enjoy power. You also want to change the world. These two incentives motivate you to pursue a political career - for the power and to do good.
Institutional Use of Economic Incentives
Businesses and governments structure economic incentives to encourage certain behavior. Let's look at government first. For example, the government has decided to tax investment income lower than earned income because it wants to encourage investment and saving. The government also wants to encourage 'family farms,' and have provided subsidies to family farms as an incentive to keep families farming. A city may want to encourage businesses to revitalize its downtown district and offers attractive tax benefits if they locate downtown. Finally, central banks will act affect interests rates to encourage or discourage borrowing.
Now, let's take a look at how businesses structure economic incentives. Businesses utilize economic incentives on both employees and consumers. Businesses offer current and potential employees salaries, bonuses, and fringe benefits as incentives to influence applicants to accept employment and for current employees to be productive. are used by employers. Intrinsic incentives may relate to the type of work offered and the nature of the work environment, which may be satisfying to certain people.
Businesses also use incentives to attract potential customers to buy their products and services. The ultimate incentive is probably price. If a price is low enough, and the product matches the needs or wants of a consumer, it can provide a tremendous incentive for purchase. Businesses can also capitalize upon a consumer's intrinsic incentives through advertising. For example, a commercial for a cruise line may depict members of a family experiencing moments of joy during various activities aboard ship. The idea is to convince the consumer that they can experience such bliss as well if they only purchased a ticket for the cruise.
Economic incentives are the things that motivate you to engage in certain behavior because they are the path towards achieving your preferences such as wealth or social status. Disincentives, on the other hand, discourage you to behave in a certain way. Extrinsic incentives come from the outside environment such as money, while intrinsic incentives are psychological, such as feeling good about your work. Governments and businesses provide economic incentives to get people to behave in certain ways.
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