1. for Your
Consideration
People Will Respond
to (.I.=) INCENTIVES
in Predictable Ways.
Lesson 9: Incentives 03/19/13 1

2. An action or policy encouraging
individuals to act in a particular
way by increasing the benefits
of their actions
Lesson 9: Incentives 03/19/13 2

3. An action or policy
discouraging individuals from
acting in a particular way
by increasing the costs
of their actions
Lesson 9: Incentives 03/19/13 3

4. Monetary (.I.=) Incentives
Characteristics
– Freedom to choose
– Inexpensive to administer
– Involves monetary cost
– can cause perverse results, e.g. cheating
Lesson 9: Incentives 03/19/13 4

5. Perverse (.I.=) Incentives
(.I.=) Incentives resulting in unintended
negative secondary effects
– Rent controls
– Agricultural price supports
– Constructs used to pay for:
» crime reduction
» informers
» urban housing
Lesson 9: Incentives 03/19/13 5

6. a Situation for your Consideration
Trash Generation
& Recycling
Lesson 9: Incentives 03/19/13 6

7. The Problem
Trash disposal space is scarce.
In many areas, trash disposal has
no monetary cost or no marginal
cost; there is no disincentive to
produce trash.
so people overuse trash disposal
services and space.
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8. The Solution
Provide monetary disincentives at the
margin for the generation of trash.
For example ~ first container costs $4; the
second container costs $10; and the third
container costs $25.
Sell trash disposal bags as the only
acceptable receptacle for trash for pickup
Allow a market in bags.
Lesson 9: Incentives 03/19/13 8

9. Possible Secondary Effects
people will burn (additional cost) their
trash
people will dump trash in unauthorized
areas (additional cost)
people will create compost (a benefit)
Lesson 9: Incentives 03/19/13 9

10. Recycling
As much as 90% of our trash can be recycled
Costs include the cost of the labor to separate the
waste; the cost of additional containers and the
cost of separate pick-up.
Some of the costs are repaid by the recycling
firm, but usually not enough to provide sufficient
monetary incentives for people to recycle.
Lesson 9: Incentives 03/19/13 10

11. Implementing the Solution
provide (.I.=) incentives to recycle
trash collectors pick up separated recyclables
following the law of comparative advantage the
people will recycle at the trash collection center
there are additional costs involved with recycling
continue recycling as long as the marginal benefits
are greater than the marginal opportunity costs
Lesson 9: Incentives 03/19/13 11

12. The Economist’s Approach
Increase the cost of the “bad” aspects –
e.g. trash production
Decrease the cost of the “good” aspects –
e.g. recycling
Use the law of comparative advantage
Continue the activity as long as the
marginal benefit is greater than the
marginal opportunity cost
Lesson 9: Incentives 03/19/13 12

13. a Situation for your Consideration
Water &
(.I.=) Incentives
Lesson 9: Incentives 03/19/13 13

14. Farmers, Water
& (.I.=) Incentives
Farmers account for 85% of water usage in California
Water is subsidized ~ so farmers pay less than 10% of
the going market rates.
Old watering techniques waste 50% or more of the
water
New watering equipment has a cost (disincentive).
No incentive exists for the farmer to invest in this
equipment because the cost (disincentive) of water use
is so low
Lesson 9: Incentives 03/19/13 14

15. How to Conserve Water
Increase marginal cost of the water used
by farmers (acts as a disincentive)
Result – as the cost of water rises, farmers
will use less water
– Farmers will use more efficient irrigation
– Farmers will switch to less thirsty crops
Institute marginal usage fees for households
Lesson 9: Incentives 03/19/13 15

16. The Economist’s Approach
If water usage in California is a problem
– stop charging a below market prices to farmers
– stop charging a zero marginal cost to households
Recognize that there will be secondary effects
– some farmers are likely to leave agriculture
– other farmers may adjust their procedures by growing
less water intensive crops
Lesson 9: Incentives 03/19/13 16

17. A Situation for your Consideration
(.I.=) Incentives
& Organ Donors
Lesson 9: Incentives 03/19/13 17

18. Addressing the Organ Shortage
People are dying because others refuse
to donate their organs at their deaths!
No incentive other than being a good
Samaritan exists.
What incentives might be introduced to
induce people to supply organs?
Lesson 9: Incentives 03/19/13 18

19. Possible (.I.=) Incentives
for Organ Donors
to pay the donors burial expenses
to pay $1000 cash (or some other amount)
to the family
other inducements
Lesson 9: Incentives 03/19/13 19

20. Possible Secondary Effects
exist for the medical personnel to cut
your life short.
Depending on the (.I.=) incentives your
family members may have incentives to
cut your life short.
The poor may have greater incentives to
donate than others.
Lesson 9: Incentives 03/19/13 20

21. Property Rights
Conserve & Develop Resources
consider your desk
consider your walls at home versus your
walls at school.
consider your dog and your “at home” lawn
versus your dog and the “city park” lawn.
Lesson 9: Incentives 03/19/13 21

22. (.I.=) Incentives to Work &
the Colonial Experience
– @ 1620 - Plymouth Plantation held in common
– One person from each family was expected to
work
– Families were given food according to the number
of people in their family
– It was believed there was gold in the vicinity
– Half the colony died after first winter
– @ 1623 - private property was established
– Then the colony flourished
22
Lesson 9: Incentives 03/19/13 22

23. So if You Want to Provide
(.I.=) Incentives to Produce
~ Establish (.P.=) Property Rights
the “women now wente willingly into
ye field and took their little-ones with
them to set corne, …whom to have
compelled would have been thought
tiranie and oppression.”
Lesson 9: Incentives 03/19/13 23 23

24. Jamestown
Each settler receives the same share of the
crops but not all work.
English “gentlemen” settlers think of
themselves as “above” work. As long as the
Governor exempts them from work they have no incentive
to work.
the Settlers starve
Captain John Smith forces the “gentlemen” to work by
offering very strong incentives.
and the “Starving Times” end
Lesson 9: Incentives 03/19/13 24

25. Discussion Points Review (a)
an (.I.=) incentive is an action or a policy encouraging
individuals to act in a particular way by increasing the
benefits associated with their actions.
a disincentive is an action or policy that discourages
individuals to act in a particular way by increasing the
costs associated with their actions.
the (.I.=) incentives can be both monetary and non-
monetary in their nature.
Lesson 9: Incentives 03/19/13 25

26. Discussion Points Review (b)
Perverse (.I.=) incentives may encourage people to act in
socially undesirable ways.
Trash production can be reduced by increasing the cost of
producing trash. Recycling can be increased by decreasing
recycling costs at the margin.
Water usage can be reduced by charging the full market
price to farmers and by increasing the cost at the margin to
households. One expects there will be secondary effects
some would consider to be negatives.
Lesson 9: Incentives 03/19/13 26

27. Discussion Points Review (c)
Providing (.I.=) incentives for organ donations will
increase the amount of organs available but will have
secondary effects.
Policies meant to encourage people to work can be
effective but they must ensure the secondary effects are
not perverse.
In general, social policy should:
– provide effective incentives
– investigate all secondary effects
– continue the policy as long as the marginal benefits are
greater than the marginal opportunity cost.
Lesson 9: Incentives 03/19/13 27

28. (i) How Do (.I.=) Incentives
& Disincentives Affect You?
Consider your study habits
– Your entire grade is based on the final. How much do
you study before each class?
– You have a quiz every class. How much do you study
before each class?
Consider overtime
– Your boss pays you your regular wage for overtime.
How much overtime do you work?
– Your boss pays you double for overtime. How much
overtime do you work?
Lesson 9: Incentives 03/19/13 28

29. (ii) How Do (.I.=) Incentives
& Disincentives Affect You?
You are being paid $5 for each “A” you get. How hard do
you work?
You are being paid $1000 for each “A” you get. How hard
do you work?
If you fail this test you will have to take it over. Do you
cheat? (And if you’re caught cheating?)
If you fail this test you will be asked to leave CSUSB. Do
you cheat? (And if you’re caught cheating?)
Lesson 9: Incentives 03/19/13 29

30. (iii) How Do (.I.=) Incentives
& Disincentives Affect You?
If you come to class you sometimes get extra credit
points.
If you come to class you get to take the quizzes.
If you stay in class to the end you sometimes get extra
credit points.
If you don’t come to class, you don’t get any of the
above.
Lesson 9: Incentives 03/19/13 30

31. If you want people to do more of an activity then
change the incentives by increasing the marginal
benefit or decreasing the marginal cost of the
activity.
If you want people to do less of an activity then
change the (.I.=) incentives by_____________
Lesson 9: Incentives 03/19/13 31

32. Policy Implications
People respond to (.I.=)
incentives in predictable
ways. Marginal incentives
do work.
Lesson 9: Incentives 03/19/13 32

33. Using (.I.=) Incentives
& Disincentives ~ Design a Policy
to induce teachers to teach well
to induce students to learn in school
to induce able-bodied welfare recipients to go
to work
to induce high school students to care for
classroom furniture
to induce farmers to leave farming
to train people to enter the work force
Lesson 9: Incentives 03/19/13 33