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In economics, we talk about incentives quite a bit. But what are incentives? Incentives are rewards and punishments that motivate behavior. You encounter incentives

In economics, we talk about incentives quite a bit. But what are incentives?

Incentives are rewards and punishments that motivate behavior.

You encounter incentives all the time. Think about what will happen if you don’t study for your economics exam. You might get a bad grade! But if you do devote time to learning the material, you’ll be rewarded with a good grade. Your grades are a familiar example of an incentive.

But incentives can be an even bigger deal than your grades – think life or death situations (no, a “D” on your econ midterm will not actually cause death).

In the late 18th century, the British government hired ship captains to transport convicted felons to Australia. Many prisoners did not the survive the voyages because the conditions on the ships were so terrible. The ones that did make it weren’t much better off, arriving sick, starved, and beaten.

The public was outraged. Parliament attempted to solve the problem with new regulations that required more humane treatment of the prisoners. But it didn’t work.

Why not? Incentives were simply not aligned -- the captains were paid whether prisoners arrived dead or alive. How did one ingenious economist propose to alter the incentives for the captains? Find out in the video!

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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.

 

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