PRINCIPLE 4: PEOPLE RESPOND TO INCENTIVES Economics Assignment Help, Economics Homework & Economics Project Help (2024)

PRINCIPLE 4: PEOPLE RESPOND TO INCENTIVES

An incentive is something (such as the prospect of a punishment or a reward) that induces a nerson to act.Because rational people make decisions by comparing costs and benefits, they respond to incentives. Youwill see that incentives play a central role in the studyof economics. One economist went so far as tosuggest that the entire field could be simply summarized “People respond to incentives. The rest iscommentary.”

Incentives are crucial to analyzing how markets work. For example, when the price of an apple rises,people decide to eat more pears and fewer apples because the cost of buying an apple is higher. At thesame time, apple orchards decide to hire more workers and harvest more apples because the benefit ofselling an apple is also higher. As we will see, the effect of a good’s price on the behavior of buyers andsellers in a market-in this case, the market for apples-is crucial for understanding how the economyallocates scarce resources.

Public policymakers should never forget about incentives because many policies change the costs orbenefits that people face and, therefore, alter their behavior. A tax on gasoline, for instance, encouragespeople to drive smaller, more fuel-efficient cars. That is one reason people drive smaller cars in Europe,where gasoline taxes are high, than in the United States, where gasoline taxes are low. A gasoline tax alsoencourages people to take public transportation rather than drive and to live closer to where they work. Ifthe tax were larger, more people would be driving hybrid cars, and if it were large enough, they wouldswitch to electric cars.

When policymakers fail to consider how their policies affect incentives, they often end up with resultsthey did not intend. For example, consider public policy regarding auto safety. Today all cars have seatbelts. but this was not true 50 years ago. In the 1960s, Ralph Nader’s book unsafe at Any Speed generatedmuch public concern over auto safety.” Congress responded with laws requiring seat belts as standardequipment on new cars.

How does a seat belt law affect auto safety? The direct effect is obvious When a person wears a seatbelt, the probability of surviving a major auto accident rises. But that’s not the end of the story because thelaw also affects behavior by altering incentives. The relevant behavior here is the speed and care withwhich drivers. operate their cars. Driving slowly and carefully is costly because it uses the driver’s time andenergy. When deciding how safely to drive, rational people compare the marginal benefit from saferdriving to the marginal cost. They drive more slowly and carefully when the benefit of increased safety ishigh. It is no surprise, for instance, that people drive more slowly and carefully when roads are icy thanwhen roads are clear.

Consider how a seat belt law alters a driver’s cost-benefit calculation. Seat belts make accidents lesscostly because they reduce the likelihood of injury or death. In other words, seat belts reduce the benefitsof slow and careful driving. People respond to seat belts as they would to an improvement in roadconditions-by driving faster and less carefully. The end result of a seat belt law, therefore, is a largernumber of accidents. The decline in safe driving has a clear, adverse impact on pedestrians, who are morelikely to find themselves in an accident but (unlike the drivers) don’t have the benefit of added protection.

At first, this discussion of incentives and seat belts might seem like idle speculation. Yet in a classic1975 study, economist Sam Peltzman showed that auto-safety laws have had many of these effects.According to Peltzrnan’s evidence, these laws produce both fewer deaths per accident and more accidents.He concluded that the net result is little change in the number of driver deaths and an increase in thenumber of pedestrian deaths.

Peltzrnan’s analysis of auto safety is an offbeat example of the general principle that people respond toincentives. When analyzing any policy, we must consider not only the direct effects but also the indirectand sometimes less obvious effects that work through incentives. If the policy changes incentives, it willcause people to alter their behavior.

[av_button label='Get Any Economics Assignment Solved for US$ 55' link='manually,http://economicskey.com/buy-now' link_target='' color='red' custom_bg='#444444' custom_font='#ffffff' size='large' position='center' icon_select='yes' icon='ue859' font='entypo-fontello']