Lesson 1.3 · Unit 1 · CA HSS 12.1.3
Monetary and nonmonetary incentives, and how behavior responds
An incentive is anything that changes the cost or benefit of an action, and the central empirical claim of economics is that when incentives change, behavior changes. Predicting how is the whole of the skill.
- An incentive is anything that alters the expected cost or benefit of an action and therefore how likely someone is to take it.
- Monetary incentives work through money: wages, prices, taxes, subsidies, fines and bonuses.
- Nonmonetary incentives work through everything else: time, convenience, status, safety, reputation, guilt and approval.
- Positive incentives reward an action and negative incentives penalize one, and both change behavior in the predicted direction.
- People respond to incentives as they perceive them, so an incentive nobody notices has no effect regardless of its size.
- Unintended consequences arise when an incentive changes a behavior the designer was not thinking about.
- A monetary incentive can displace a nonmonetary one, so paying for something previously done from duty or goodwill sometimes reduces it.
Where students lose marks: answering that people respond to incentives without saying which margin moves. The analysis is naming the specific behavior that becomes cheaper or dearer and predicting the direction of the change.
Constructed cases. Four invented policies. For each, name the incentive, the margin it moves, and the response the designer did not intend.
Policy one: a charge of 0.10 per plastic bag at checkout.
Step one: identify the margin. The cost of taking a bag rises from zero to 0.10, so the decision that changes is whether to take one rather than whether to shop. Bag use falls sharply.
Step two: notice the size puzzle. Ten cents is trivial, yet bag use in such schemes falls a great deal. Part of the effect is monetary and part is nonmonetary: the charge makes bag use visible and slightly embarrassing, and the nonmonetary component does much of the work.
Policy two: a late fee of 3 per day at a children's nursery, introduced because parents collected children late.
Step three: predict naively. Lateness now costs money, so lateness should fall.
Step four: identify the displacement. Before the fee, lateness carried guilt and the disapproval of staff, a nonmonetary cost many parents treated as large. After the fee, lateness became a service with a posted price, and a parent who considers 3 good value for twenty extra minutes can now buy it with a clear conscience. Lateness can rise, which is the incentive backfiring.
Step five: state the general lesson. Introducing a price can remove a moral cost that was larger than the price. The designer must ask what nonmonetary incentive is already operating before adding a monetary one.
Policy three: paying teachers a bonus tied to test scores.
Step six: identify all the margins it moves. It rewards raising scores, which can be done by teaching better, by teaching only what is tested, by spending time on students near the passing mark rather than those far above or below it, or by misreporting. The incentive is attached to the measure rather than to the goal.
Step seven: state the principle. An incentive moves every behavior that affects the measured quantity, not only the behavior intended. Designing one therefore requires listing the cheapest ways to move the measure, not the most virtuous ones.
Policy four: a subsidy of 2,000 toward installing home insulation.
Step eight: work out who responds. Households that would have insulated anyway collect 2,000 for doing so, which changes no behavior and costs the budget. Households just short of the threshold are moved to act, which is the intended effect. Evaluating the policy means estimating what share falls into each group, and that is an empirical question rather than a matter of opinion.
Questions 1 to 5 are recall. Questions 6 to 10 ask for reasoning.
- Define an incentive.
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Anything that alters the expected cost or benefit of an action and therefore how likely it is to be taken
- Give three examples of monetary incentives.
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Wages, prices, taxes, subsidies, fines and bonuses
- Give three examples of nonmonetary incentives.
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Time, convenience, status, safety, reputation, guilt and approval
- Distinguish positive from negative incentives.
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Positive incentives reward an action; negative incentives penalize one
- Why does an unnoticed incentive have no effect?
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Because people respond to incentives as they perceive them, not as they are written
- Why does a ten cent bag charge change behavior so much?
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Because it operates on two margins at once. The monetary cost of a bag rises from zero to ten cents, which is genuinely a change from free to not free even though the amount is trivial. More importantly, the charge makes the decision visible: the shopper must actively ask for a bag and be seen paying for it, which attaches a small nonmonetary cost of awkwardness. The nonmonetary component does much of the work. It adds a small money cost and a larger visibility cost at the same time
- Explain how the nursery late fee could increase lateness.
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Because before the fee, collecting a child late carried guilt and the visible disapproval of staff, and many parents treated that nonmonetary cost as substantial. Posting a price of 3 converts lateness from a transgression into a purchasable service, so a parent who values twenty extra minutes at more than 3 can now buy them with a clear conscience. The monetary cost added is smaller than the moral cost removed. The posted price removed a moral cost larger than the price it added
- What should a policy designer check before adding a monetary incentive?
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What nonmonetary incentive is already operating, and how large it is. If duty, reputation, guilt or professional pride is already restraining the behavior, attaching a price may displace that restraint and make things worse rather than better. The relevant question is not whether the new incentive points the right way but whether it is larger than whatever it replaces, and that requires knowing what is already there. Whether an existing nonmonetary incentive is larger than the price being added
- Why is a bonus tied to test scores difficult to design well?
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Because it attaches the reward to the measure rather than to the goal, and every behavior that raises the measure is thereby encouraged. Scores can be raised by teaching better, which is intended, but also by narrowing teaching to only what is tested, by concentrating effort on students just below the passing mark where a small gain moves the number most, or by misreporting. Designing an incentive means listing the cheapest ways to move the measure. It rewards the measure, so every cheap way of moving that measure is encouraged
- How would you evaluate the insulation subsidy?
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By estimating what share of recipients changed their behavior because of it. Households that would have insulated anyway collect 2,000 for doing what they had already decided to do, which costs the budget and changes nothing. Households that were just short of acting are moved to act, which is the entire point. The policy is worth its cost only if the second group is large relative to the first, which is an empirical question requiring data rather than argument. Estimate how many recipients changed behavior against how many were paid for decisions already made