People Respond to Incentives: Study with Video Lessons, Practice Problems & Examples

Economic Incentives

Next, we have the idea that people respond to economic incentives. Right? So incentives. It's people taking advantage of opportunities to make themselves better off. A lot of times in these classes, they use the word exploit. Right? They exploit opportunities to make themselves better off. I saw this really funny example. It was about getting an oil change in New York City. So in NYC, parking for the day when you go downtown to go to your job, you could be spending for all-day parking upwards of 40, 50. I don't know. Someone from New York could probably tell us better, but parking in New York is no joke. So what people started doing was realizing that they could go to a mechanic and just get an oil change, and the oil change ran them let's say $25, $30, and they ended up being able to leave their car at the mechanic all day. So people started just going to the mechanic and getting an oil change, and it's cheaper, literally than just parking for the day. It's crazy. And another example, something very simple. What about apples? You know, when the prices of apples go up, people stop buying apples. They start buying oranges or they buy something else. Right? They're going to exploit opportunities to make themselves better off. Oh, apples are going to be more expensive. The price goes up. Well, I'll take my business elsewhere. The quantity of apples, it's going to go down there. People aren't going to be buying apples anymore. They're going to buy something else. So they're going to take advantage of that opportunity.

Here’s what students ask on this topic:

What are economic incentives and how do they influence consumer behavior?

Economic incentives are rewards or penalties that motivate individuals to take certain actions. They influence consumer behavior by encouraging people to make decisions that improve their well-being. For example, if the price of apples increases, consumers may switch to buying oranges instead, as they seek to maximize their utility while minimizing costs. This behavior demonstrates the law of demand, where higher prices lead to lower quantities demanded. Economic incentives can also include non-monetary factors, such as convenience or time savings, which further shape consumer choices and market dynamics.

Can you provide an example of how people exploit economic opportunities to make themselves better off?

One example of people exploiting economic opportunities is the case of parking in New York City. Parking for a full day can be very expensive, often costing $40-$50. Some individuals discovered that getting an oil change, which costs around $25-$30, allowed them to leave their car at the mechanic all day. This was cheaper than paying for parking, so they opted for the oil change instead. This behavior illustrates how people respond to economic incentives by finding ways to reduce costs and improve their financial situation.

How does the law of demand relate to economic incentives?

The law of demand states that, all else being equal, as the price of a good increases, the quantity demanded decreases, and vice versa. Economic incentives play a crucial role in this relationship. When prices rise, consumers are incentivized to seek cheaper alternatives or substitutes, thereby reducing the quantity demanded of the more expensive good. For instance, if apple prices go up, consumers might buy oranges instead. This shift in behavior due to price changes highlights how economic incentives drive consumer decisions and market outcomes.

What is consumer surplus and how is it affected by economic incentives?

Consumer surplus is the difference between what consumers are willing to pay for a good or service and what they actually pay. It represents the extra benefit or utility gained from purchasing at a lower price. Economic incentives, such as price changes, can significantly impact consumer surplus. For example, if the price of apples decreases, consumers who value apples highly but were previously deterred by the cost will now purchase them, increasing their consumer surplus. Conversely, if prices rise, consumer surplus decreases as fewer people are willing to buy at the higher price.

How do elasticity of demand and economic incentives interact?

Elasticity of demand measures how sensitive the quantity demanded of a good is to changes in its price. Economic incentives influence this sensitivity. If a good has high price elasticity, a small price change will lead to a significant change in quantity demanded. For example, luxury items often have high elasticity because consumers can easily forego them if prices rise. Conversely, necessities tend to have low elasticity. Understanding elasticity helps businesses and policymakers predict how changes in prices, driven by economic incentives, will affect consumer behavior and market demand.