Incentives

An incentive is a thing that motivates or encourages a person to act in a certain way. Incentives influence decisions by altering the perceived costs and benefits of different actions. They are central to economic theory and to the design of organizational and policy interventions.

In economics, incentives are typically categorized as monetary and non-monetary. Monetary incentives include wages, bonuses, subsidies, tax credits, fees, and penalties. Non-monetary incentives include recognition, status, opportunities for advancement, autonomy, and regular feedback. Incentives can be positive (rewards) or negative (punishments), and they may be direct or indirect, such as price signals that steer consumer behavior.

Classical microeconomic theory emphasizes that well-designed incentives align the interests of principals and agents. However, misaligned incentives can cause unintended outcomes or moral hazard, where individuals manipulate the system. Behavioral economics highlights extrinsic incentives possibly crowding out intrinsic motivation and the importance of credibility, transparency, and verifiability. Effective incentive design considers goals, measurability, risk, equity, and legality.

In organizations, incentive systems aim to improve productivity, retention, and quality. In public policy, incentives such as subsidies, tax credits, carbon pricing, or mandates seek to influence behavior on issues like energy use, health, and education. In healthcare, pay-for-performance schemes intend to improve outcomes; in education, performance-based funding or scholarships aim to raise achievement. The success of incentives depends on context, monitoring, and avoiding gaming or perverse incentives.

Related concepts include motivation, incentive compatibility, and principal-agent problems. Incentives are a tool, not a universal solution, and should be designed with ethical considerations and long-term effects in mind.