Understanding incentives

0:00- [Narrator] So let's talk a little bit about incentives. You might already know what this word means in everyday language. If you give someone an incentive, you're giving them a reason to do something, and it could be a reward or it could be a punishment. For example, if your parents said, if you don't clean your room, you are not going to go to that party tonight.

0:22That is an incentive for you to clean your room. Or if your parents say, hey, if you get straight A's, then I will buy you that fancy, I dunno, technological gadget that you want. That reward of that gadget is an incentive for you to get straight A's. What we're gonna do in this video is think about incentives in terms of the economy and the different categories of folks or players or parties in the economy.

0:50And oftentimes in one context you might be a say consumer and then in another context you are a producer. So it's not always different groups of people, but let's separate them out right now. So let's think about consumers. So these are the people who buy things out in the market, oftentimes things that they will consume or use or enjoy in a certain way, and what tends to motivate consumers to buy something?

1:18Well, incentives could include lower price, lower price. There could be some loyalty reward program. I was just on a plane yesterday and I definitely make sure they know my frequent flyer miles and when everything else is equal. If I had to pick between two airlines, I tend to pick the airline that I already have more rewards on, more frequent flyer miles on because I want those to accumulate so that they have created an incentive for me to stick with that airlines in that example.

1:53But they do that with hotels and all sorts of things, even stores, et cetera. We can similarly think about producers and here we would think about how do we think of incentives for them to produce one thing or another or not produce one thing or another. Well, something that can be a bit punitive.

2:10Let's say they were producing something that produces a lot of harm somehow, maybe it produces pollution or it's not good for people's health. Well, maybe the government might decide to tax or regulate it, which makes it a little bit more expensive to produce it or harder to generate profit.

2:27So that would be incent or maybe let me write, motivate, motivate to not do or provide an incentive to do something else, to provide a cleaner product or one that is actually safer. You could also have tax breaks. If there is something that, let's say the government really wants that producer to produce, they might say, if you do that, let's say you invest in housing in an area people aren't investing in, or you produce that get higher mileage or that are electric or don't generate as much pollution, then maybe we'll give you some tax breaks.

3:06Those would be incentives for those producers to do in that case what the government wants them to. Now, there's other types of incentives, but I'll keep going. So we could think about workers and workers in their everyday lives once they go home and they go to the mall, they become consumers and workers when they're working, they oftentimes will work for a producer or they could even be producers themselves if they are individually employed.

3:30But one of the biggest incentives for workers is going to be wages, but it's not just wages that the higher you get paid, the more that you're going to want to do that job. It might be work conditions. I think no matter how much you pay someone, if the conditions aren't safe, if they aren't healthy, if they're super hard or the hours are ridiculously long, no one is going to want that.

3:54You could think about benefits. Maybe they provide a pension plan or good health insurance. These would all be incentives for taking that job. Now, throwing out another category, and once again these are not exclusive. Someone can be a consumer, a worker, a saver and actually in certain cases a producer.

4:13But these are the different roles of their life. Or they could be different parties, but a saver. Why do you want to save your money? Or what would be incentives to save your money? Well, you could get a high return on your money, maybe a high interest rate or wherever you're investing it, you think you'll be able to get a lot of that back plus some interest or plus some return.

4:37One incentive for saving is you might think the world is risky and you better save money. Maybe you feel like your job is in jeopardy and you need to keep some money saved for a rainy day. So that would be an incentive for you to save money. Similarly, and investors and savers are similar because when you save money, and as long as you're not stuffing it into your mattress, if you're putting it into a bank, if you're putting your savings into something or another, usually that money is being used to invest in someplace.

5:10That's how you are getting that interest. But if we want to be a little bit more particular, we could also say investors. And when we think of investors, we might think someone who more explicitly will save money and put it into say something like stocks or put it into a business, but it's the same idea.

5:25They might see that they have an opportunity for a high return. There's usually more risk when you're thinking about stocks or investing in a business, but they might see a high risk or reward versus risk profile. And then the last group I'll talk about, because we all live in a society with a government and we need to pass laws and regulations, is we all have roles as citizens.

5:52As citizens, and there are motivations for citizens to do certain things. For example, you might have individual tax policies. And these individual tax policies, and this might be closely linked with consumer. They might motivate a citizen to do something or another.

6:11For example, you get a tax credit if you get solar panels, which happen to us a couple of years ago. So that made us more likely as consumers to go out there and get some solar panels that effectively lowered the price. In some ways it made us investors there too because we got a return by those tax breaks, lower price on the solar panels, the money we put into the solar panels.

6:34We got a pretty good return on it in terms of the electricity that we saved. But there's government policies that also keep us in line, not just from a financial point of view. You could have threat of jail, of punishment, of fines. These are incentives that keep us from say driving too fast or hurting each other or stealing from each other.

6:55All of the rule of law in many ways, these are incentives. They're meant for us to behave in certain ways, ideally these are last resorts. But just the idea that they exist is an incentive to not do what our society thinks are bad things.