Chapter 2 Wheelan Flashcards
Perverse incentives (law of unintended consequences)
Inadvertent incentives that can be created when we set out to do something completely DIFFERENT. (counter-intuitive)
What is the problem with a uniform pay scale? (adverse selection)
Provides an incentive for the most talented to look for work elsewhere
What does a teacher’s uniform pay scale create?
Adverse incentives
How do incentives help a market?
- Rewarding productivity, punishing inefficiency
- Rewarding winners
- Crushing losers
raising prices
reduces demand
rhino market
not naturally self-correcting. demand is low price is high, more reason for poachers to hunt and sell
communal property
many owners
not altruism
maximizing value of a scarce resource
government provides incentives in form of
permits and revenues
when illegal or regulated
demand decreases and it lowers incentive for poachers to hunt rhinos
incentives as commission
harder working employees
incentives for high gas prices
less driving
self interest
makes the world go round
money is an
imperfect, sometimes ineffective incentive
inputs
something you can control directly
good policy
uses incentive to some positive way. Ex: London and driving restrictions. Flaw- reduced tourism and car traffic revenues declined
good policy
uses incentive to channel behavior toward some desired outcome
bad policy
ignores incentive or fails to anticipate how rational individuals might change their behavior to avoid being penalized
corporate America
cesspool of competing and misaligned incentives
Principal-agent problem
Difficulties in motivating one party (the “agent”), to act in the best interests of another (the “principal”) rather than in his own interests (ex: Burger King preventing employees stealing)
principal agent - how does it work
for BK to not waste time monitoring employees they provide an incentive to the buyer to notify if they are not given a receipt. a type of management tool
stock options
Allows recipient to purchase the company’s stock at a predetermined price.
Ex: aligns incentives of
CEOs to that of shareholders to ensure they do a good job.
Toxic assets
Financial assets whose value has fallen significantly and for which there is no longer a functioning market, so that such assets cannot be sold at a price satisfactory to the holder
negative factor of stock options
CEOs can achieve short term success, get compensated, and leave a disaster behind
challenge is to reward good outcomes without
creating incentives for employees to game the system in ways that can damage the company in the long run
economics teaches us how to
get incentives right
in some cases individuals will make themselves worst off…
even if they are being completely rational. Ex: Prisoner’s dilemma
Prisoner’s Dilemma
It offers great insight into real world situations in which unfettered SELF-INTEREST leads to POOR OUTCOMES.
Creative destruction
Capitalist economic development ARISES out of the DESTRUCTION of some prior economic order
Government’s role in creative destruction
Help FIRMS and industries under siege from competition and to protect the affected WORKERS
government benefits
perverse incentives:
- generous unemployment benefits diminish incentive to work
- medicare/social security discourage saving money for old age
- save less because we need to set aside less money for retiring
income tax
discourages unemployment
green tax
collects taxes and makes people drive less. Conserves fuels as an incentive
sin taxes
taxes on smoking, alcohol, and gambling
simple level of taxation
understood and collected
fair taxation
two people with same income will pay same or similar taxes
broad taxation
revenues raised from imposing taxes on a large group rather than smaller
Deadweight loss
Taxes make individuals worse off without making anyone else better off.
Ex: taxing only red car owners.
economics
offers an analytical framework to think and ask important questions but no right answer
carbon based taxation
incentive to conserve non renewable resources
regressive tax
falls more heavily on the poor than the rich
lump sum tax
- most efficient. broad simple and fair
- imposed uniformly on every individual in a jurisdiction
Earned income tax credit (EITC)
Uses income tax system to SUBSIDIZE low wage workers so that their TOTAL income is raised ABOVE the poverty line
economy
wants to understand how people behave and react to try to be better off, so economists can predict accordingly.
systems work better with
incentives
