Incentives

What is an incentive? Incentives are rewards and punishments that motivate behavior.

Incentives are everywhere. To better understand this critical economic concept, let's turn to an example from 1787, when the British government hired sea captains to ship convicted felons to Australia. The conditions on those ships were awful. On one voyage, more than a third of the men died, and the rest arrived beaten, starved and sick. The public was outraged. Newspapers called for better conditions. The clergy appealed to the captains' sense of humanity, and British Parliament passed regulations requiring better treatment of these prisoners. Unfortunately, those attempted solutions simply didn't work. The death rate remained shockingly high.

But there was one economist at the time who came up with a novel solution. Instead of paying the captains for each prisoner who embarked to Australia, the government would pay the captains only for the prisoners who arrived alive. Overnight, the incentives of the sea captains changed. The survival rate of the prisoners shot up to 99%. As one observer put it, "Economy beat sentiment and benevolence."

So as you can see, incentives are a fundamental economic concept that help us predict human behavior. But they aren't the only fundamental concept.