Day 5: Incentives – Why People Behave the Way They Do [How to Think Like an Economist]

Missed Day 4 ? Check it out ?? Sunk Cost Fallacy Today, we’re diving into Incentives.

Ever wondered why people act the way they do? Why do employees work harder for bonuses? Why do discounts make us buy things we don’t need? The answer lies in incentives—the hidden forces that shape our decisions every day.

Understanding incentives is like having a cheat code for life. When you know what motivates people (including yourself), you can make better decisions, influence outcomes, and avoid being manipulated by bad incentives.

What Are Incentives?

An incentive is anything that motivates or influences behavior. Incentives can be financial, social, or personal, and they can encourage either good or bad behavior.

?? Key Idea: People respond to incentives—whether they realize it or not.

Types of Incentives and Real-Life Examples

1. Financial Incentives (Monetary Rewards & Penalties)

• Bonuses at Work: Employees work harder when they know they’ll receive a performance-based bonus.
• Sales & Discounts: Ever bought something just because it was “50% off”? That’s the power of financial incentives.
• Taxes & Fines: Governments use fines to discourage bad behavior (like speeding tickets) and tax breaks to encourage good behavior (like tax deductions for donations).

2. Social Incentives (Approval & Recognition)

• Likes & Comments on Social Media: People post content that gets them more likes, shaping online behavior.
• Peer Pressure: If your friends are all going to the gym, you’re more likely to join.
• Reputation & Status: Many people work hard to gain promotions, titles, or social respect.

3. Moral & Personal Incentives (Internal Motivation)

• Volunteering & Charity: Some people donate time or money because it aligns with their values, not for rewards.
• Personal Growth: Learning new skills, reading books, or exercising are driven by personal goals, even if there’s no immediate reward.

The Dark Side of Incentives – When They Backfire

Not all incentives work as planned. Sometimes, they lead to unintended consequences.

• “Paying Kids to Get Good Grades” – If children are only rewarded with money for good grades, they may lose interest in learning once the money stops.
• “The Cobra Effect” – In colonial India, the government offered money for dead cobras to reduce their population. Instead, people started breeding cobras to kill and claim the reward. The result? More cobras than before!
• “Workplace Burnout” – Companies offering high bonuses may push employees to overwork, leading to stress and quitting.

Lesson: Incentives must be designed carefully to encourage the right behavior.

How to Use Incentives to Your Advantage

Step 1: Identify the Incentives at Play

Ask yourself: Why am I (or someone else) making this choice? What is the reward or consequence?

Step 2: Align Incentives with Your Goals

• Want to exercise more? Reward yourself with a fun activity after workouts.
• Want to save money? Automate savings before spending.

Step 3: Be Aware of Manipulative Incentives

• Marketers use “limited-time offers” to create false urgency.
• Social media algorithms are designed to keep you scrolling.

Final Thoughts: Incentives Drive the World

Everything from your job to your spending habits is shaped by incentives. The more you understand them, the better you can make smarter decisions, set better habits, and avoid being influenced by bad incentives.

What’s an example of an incentive that has influenced you recently? Let’s discuss in the comments! ??

?? Day 6: Comparative Advantage – Focusing on What You Do Best