An incentive is something that motivates an individual to perform an action. The study of incentive structures is central to the study of all economic activities both in terms of individual decision-making and in terms of cooperation and competition within a larger institutional structure. Perhaps the most notable incentive in economics is price. Price acts as a signal to suppliers to produce and to consumers to buy. For example, a sale is nothing more than a store providing an incentive to potential customers to buy.
The lowering of the price makes the purchase a better idea for some customers; the sale seeks to persuade individuals to change their actions namely, to buy the product.
Sales are Incentives : Sales are incentives for consumers to buy, because firms know consumers generally respond to lower prices by purchasing more.
Similarly, the increase in price acts as an incentive to suppliers to produce more of a good. If suppliers think they can sell their products for more, they will be inclined to produce more. The price acts, therefore, as an incentive to customers to buy and suppliers to produce.
Incentives come in many other forms, however. Broadly, most incentives can be grouped into one of four categories:. Economics is mainly concerned with remunerative incentives, though when discussing government regulations, coercive incentives often come into play. By manipulating incentives, individuals as well as businesses and governments hope to encourage some behaviors and discourage others. Companies leverage incentives-based strategies to drive performance and optimize employee decision-making and behaviors through meaningful reward systems.
While there are both advantages and drawbacks to this type of approach, remunerative financial incentives are highly attractive options for employers in a variety of industries and businesses.
Providing incentives such as variable income, where an individual can obtain more personal rewards for successfully creating a product or making a sale, often drives up production for highly motivated employees. An example of this would be a manufacturing facility making widgets. The floor manager shifts the wage system from an hourly wage perspective to a straight piece rate system.
The more widgets a worker creates, the higher his or her prospective income will be. Under this incentive system less productive workers may stay the same, but highly productive workers will respond by increasing their production. Privacy Policy. Skip to main content. Principles of Economics. Search for:. Individual Decision Making. Scarcity Leads to Tradeoffs and Choice When scarce resources are used, actors are forced to make choices that have an opportunity cost.
Learning Objectives Give examples of economic trade-offs. Key Takeaways Key Points Scarce resources diminish as they are used and almost all resources are scarce. In order to use a scarce resource, you are inherently using the resource for one purpose and not an alternative. The cost of using a resource is called the opportunity cost: the value of the next best alternative that you could be using the resource for instead. Key Terms Scarce : Insufficient to meet demand.
Opportunity cost : The value of the best alternative forgone. Individuals Face Opportunity Costs Individuals face opportunity costs when they choose one course of action over another. Government became increasingly secretive, coercive and unresponsive to Soviet citizens. Personal and economic freedom were increasingly curtailed. High growth rates held through the s and s, and Stalin maintained his choices in the economic sphere, placing heavy emphasis on capital goods and military production, with the resultant benefits and costs: The Soviet Union was able to withstand the onslaught of Nazi Germany in W.
II and continue a heavy military emphasis during the s and 60s. Important benefits were to reinforce the dream of empire and the willingness of the populace to bear costs. Gratitude to the government for defeating the Nazis lifted spirits even higher. Forced emphasis on specific sectors of the economy was well suited for accelerated growth of those sectors at the expense of others often agriculture.
This provided the opportunity for heavy investment in space exploration and military innovation. The willingness of citizenry to bear costs continued, sustained by a combination of fear and belief. Continued emphasis on industrial and military production perpetuated low living standards for the masses of the people.
Immediately following W. II, life for the average Soviet citizen was so miserable that any improvement seemed significant. Rapid growth during the s and 60s allowed for some increases in consumption levels from those of the s and 40s and these increases purchased years of legitimacy and genuine support for the system. By the s and 80s, consumption production was virtually flat; the standard of living of the average Soviet citizen did not change and prospects for future wealth seemed less promising.
In addition, advances — technological, economic, and military — were smaller than in the past. After , the Soviet economy began to slow down. This slow down is put into perspective when we realize that investment spending remained extremely high and that it was fueled by the huge oil revenues the Soviet Union received as a result of high world petroleum prices.
In hindsight, the beginning of the end is apparent by the early s. Despite strictly enforced central planning, the Soviet system began to look as if it were out of control. The costs of negotiating and monitoring transactions among firms and regions became extraordinarily high. While innovation in production techniques and new product development was providing much of the rest of the world with higher quality products at lower prices, and was producing a virtual revolution in computer and information technology, the Soviet Union was stalled with out-dated production techniques, decades-old machinery, and inefficient communication.
The system that had borrowed western technology to fuel its industrial growth seemed incapable of entering the new information age.
Agricultural output, in spite of heavy investments by Khrushchev and Brezhnev, was declining annually. The western free world was moving farther and farther ahead, not only in much desired consumer goods, but also in the showcase areas of military strength and space technology.
Continued high investment in the military and heavy industry sustained limited gains in consumer goods; Investment means resources were directed to industrial and military growth, and thus taken away from consumer production. Investment in industry may promise consumer production in the future, but for the present, it causes standards of living to erode or stagnate.
Agricultural problems became acute; Distributions from farms to cities were sporadic; and Oil revenues declined dramatically. Under Gorbachev, Perestroika lowered the cost and raised the benefit of diverting resources from the official sector to the informal economy. In the political-legal area, political control was used to deliver the privileges to the elite and rule of law was absent.
The prosecuting attorney was also the judge. In the moral-cultural sphere, there was a loss of moral principals that worked in the economic system. Citizens believed that theft from the state was necessary and justified. These economic problems were aggravated by the Soviet people beginning to reject the secrecy of their history and to question the communist plan and the dream that accompanied it.
With two legs of the 3-legged table seriously weakened, all the strength and force of the 3rd leg could not save the whole, and the structure collapsed. Conclusion: The cost of decades of choices to invest in industry and the military, to restrict individual freedoms, and to remain isolated from western cultures and economies finally became more than the Communist Party and the people of the Soviet Union were willing to pay. Activity: A Journey of Choices Lesson Overview: In the first part of this 2-tiered activity, students learn to identify alternatives and opportunity costs by looking at the journey of choices they make as they go through a typical school day.
Materials: Student handouts — please see the download file for editable masters of student handout Time required: 2 class periods Procedures: Part 1 Introduce the concept of opportunity cost to students by developing the following example in a large-group, interactive lecture-discussion.
When your alarm went off, or your mother called you, what choice did you face this morning? Accept a variety of answers and list them on the board. Then, ask students to reduce the choice to the two best alternatives.
Essentially, these are: to get up or not get up. Why did you have to make this choice? You are limited in the ways that you can use your time.
What benefits do you give up? Another way to look at it is that the benefit of making a choice becomes the opportunity cost of not making the choice. Note: Students will try to bring consequences into the discussion.
For example, it may be true that because you decide to sleep in, you drive faster to get to school and get in an accident. While accepting the increased risk of an accident is a part of the decision process and therefore an opportunity cost, an actual accident is a consequence rather than an opportunity cost.
In identifying opportunity costs, encourage students to focus on the choice itself and the benefits of the alternative, not on things that might come into play later. Direct students to work with a partner. Post the following list of choices on the board or overhead: eat breakfast ride the bus walk your homecoming date to class and arrive tardy to your own go out to lunch cut your last class go in after school for help in physics Directions to student pairs: Choose 3 entries from the list.
For each entry: identify the next-best choice list the benefits of each of your two alternatives for example, what are the benefits of eating breakfast? Allow students to share their responses with the large group. Ask them to generate some generalizations about cost. Post these on the board. Emphasize: Choosing is Refusing — what are the benefits you are refusing by making the choice? The benefits you refuse are the opportunity cost of your choice.
Individuals will place different value on the relative benefits of a set of alternatives and will thus make different choices. Note: Benchmarks for Economics Content Standard 1 include: The evaluation of choices and opportunity costs is subjective; such evaluations differ across individuals and societies. Suggest an alternative saying that more accurately reflects reality. What happens when we change the benefits and costs of a situation?
Suppose the alarm rings on a Saturday morning when you hope to go skiing with friends. Are the alternatives the same? Choose one of the items from the list. How would they change? Would your choice change? Why or why not? Share team examples with large group. For each decision you made, rate the opportunity cost as high or low. Rate your day so far — good day or bad day? Do good days have high or low opportunity costs? Careful thought reveals that, although it is counter-intuitive, good days have high opportunity costs.
The thinking is this. While mainstream economics focuses on the preferences and decisions of individuals in society, evaluating the allocation of scarce resources within a society necessitates some aggregation of preferences in order to judge the utility of an allocation to society as a whole see the article on welfare economics.
Thus, not only the efficiency of an allocation but also its equity, or distributive fairness, is relevant to the study of scarcity and choice. Indeed, the issue of equity is central to the debate on free-market versus planned economies. The scarcity of a resource in a particular context can be quantified and hence judged objectively.
The basics of supply and demand tell us that the price of a rare item will be higher than that of a common one. Marketing teams often apply the concepts of scarcity and choice along with ideas from psychology to make money: if the impression can be given that an item is in scarce supply then some people will be willing to pay more for it, or to bring forward their purchases. Perhaps the most important and pressing issue of our time, that of climate change, is essentially a problem of scarcity and choice.
As the very air we breathe comes under threat and our rivers begin to run dry there has never been a greater urgency to consider economics in the search for practical solutions. The subfield of environmental economics deals with emissions targets and permits, carbon taxes, and subsidies for renewable sources of energy. It will surely be one of the most in-demand areas for economists to work in the years to come.
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