1.3 Key Principle of Economics: People Respond to Incentives
Another guiding principle in economics is that people respond to incentives. Incentives Inducements to act in certain ways. are inducements to act in certain ways. Depending on their structure, incentives can either encourage or discourage particular behaviors. Suppose you’re walking down the sidewalk, and you see a penny. Do you stop and pick it up? If not, would you stop for a nickel? A quarter? A dollar? A twenty? Incentives, as in this case, often appear in the form of benefits. Benefits, in turn, encourage rewarded behaviors. Incentives imply that if you want some people walking down the sidewalk to stop and bend over, you can get them to do it by leaving a coin on the sidewalk. If you want more people to bend over, leave a bill instead.
Incentives can also appear in the form of costs. Suppose that you’re one of the cheapskates willing to pick up a penny from the sidewalk. Now, suppose that instead of being on the sidewalk, you’re at the altar exchanging your wedding vows. Do you pick up the penny now? Because no matter what everyone tells you, at least half of this day belongs to your spouse. And if you interrupt the “Do you takes” to pick up a penny (or a dime, or a dollar), there’s little chance you’ll ever be allowed to forget it. The simple lesson is that one way to discourage particular behaviors is to increase the costs associated with them.
Perverse Incentives
Perverse incentives exist when programs designed to discourage particular behaviors end up encouraging them instead. What flaw in the plan to eliminate cobras resulted in the cobra effect? How could that flaw be corrected?
It’s important for policymakers to understand incentives. Governments can use the power of incentives to encourage behaviors that society wants more of and to discourage behaviors that society wants less of. The U.S. government, for example, uses both benefits and costs to encourage you to drive a more fuel-efficient automobile: You qualify for a tax credit if you purchase an all-electric Tesla, but you’ll pay a surtax if you choose a gas-guzzling Lamborghini. The government also encourages altruism by allowing you to deduct charitable donations from your taxable income; it encourages communities to build large-scale tornado shelters by helping to pay for their construction; it nudges individuals to lead healthier lifestyles by taxing cigarette purchases. Not all incentives need to be measured in dollars: The government enacts laws to discourage crime; the incentives those laws create are often measured in time (twenty years to life, for example) rather than money.
Application 1.3: Incentives and the Law of Unintended Consequences
The actions of people, and especially of government, often have unpredictable or unwanted effects. This law of unintended consequences encapsulates the idea that public policy actions alter incentives, and that people often respond to those incentives in unanticipated ways.
Nowhere has the law of unintended consequences ever been more dramatically illustrated than in the 1994 Caribbean Cup soccer tournament. You know soccer, right? Round ball, two goals, 90 minutes, the team that scores the most goals wins?
In the 1994 Caribbean Cup, one small rule change turned the game tush over teakettle!
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Well, that’s the way it’s supposed to be . . . but in the ’94 Caribbean Cup, that’s not exactly how it turned out! In group play, Barbados, Grenada, and Puerto Rico were playing round-robin style to determine which of the three would advance to the tournament finals. If Barbados could win against Grenada in the last game of group play, each team would finish with one win and one loss; in that case, the team with the largest goal differential (goals scored minus goals allowed in all games) would advance. Because Grenada was coming into the last group game with a bigger goal differential, Barbados would have to win by at least two goals to go to the finals.
Fast forward to the last few minutes of regulation play, where Barbados finds itself ahead of Grenada by a single goal—enough to win the game, but not enough to advance. This is the precise moment where rules and incentives turn into unintended consequences. With just moments to play and another goal unlikely, Barbados has only one viable option left: Force a tie and buy another fifteen minutes by sending the game into overtime. There, the first team to score would win the game, and because of an oddity in the rules, would be awarded not one goal, but two—enough for Barbados both to win the game and eclipse Grenada’s score differential.
And so, with just three minutes left to play, Barbados defender Terry Sealey purposely kicks the ball into his own goal to force the tie!
But that’s just where the crazy begins! After a few confused seconds to sort out what Barbados is doing, Grenada realizes that because of its greater score differential, it will advance to finals play if it can score a goal—no matter whose goal it scores it in! This leads to an odd spectacle: Grenadian soccer players running around the field desperately trying to kick the ball into a net—any net—and Barbados guarding not only its own goal, but also Grenada’s!
It's a gambit that worked for Barbados. Grenada failed to score in either goal during those last crucial moments; the game went into overtime, and ultimately Barbados struck first, notching a 4–2 win and the score differential it needed to advance to the final tournament.
The Moment Soccer Turns Into Something Else Entirely!
In this topsy-turvy match, nobody seems to know where to kick the ball, nor which goal to defend!
Grenadian manager James Clarkson was furious. “I feel cheated. In football, you are supposed to score against your opponents in order to win, not for them.” And this unlikely outcome, in which a few minor and largely unobjectionable tweaks to the rules of soccer resulted in teams trying to score in their own goals while defending those of their opponents, is a dramatic demonstration of both the power of incentives and the law of unintended consequences.
Refer to related problem 9 at the end of this section.
All incentives, whether they appear as costs or benefits, work by changing the trade-offs individuals face. That makes some options appear more attractive and others less so. If the trade-offs change enough, people may be convinced to act in ways that they ordinarily wouldn’t. We’ll spend the rest of this text thinking about the incentives people face, and how perverse or misaligned incentives might lie at the root of many of our biggest social problems.