Intuition might tell us that people respond to incentives. Economics deals with human beings, and what might seem to be a common sense statement reveals more complex relationships which make outcomes different from those expected.
Research by Gneezy, Meier and Ray-Biel (2011) highlight some of these complexities. Their research suggested that incentives may work better in certain circumstances than in others. Policymakers need to consider a wide variety of issues when deciding on putting incentives in place.
First, they must consider the type of behaviour to be changed. For example, society might want to encourage what Gneezy et al. call ‘prosocial’ behaviour. This might include donating blood, sperm or organs; increasing the amount of waste put out for recycling; attending school, college or university; working harder in education to improve grades; installing insulation or solar panels in homes to reduce energy waste; or finding ways of encouraging people to stop smoking.
Policymakers then must consider the parties involved. This can be expressed as a principal–agent issue. The principal is a person or group for whom another person or group, the agent, is performing some act. In encouraging people to stop smoking, the smoker is the agent and society is the principal. Next, the type of incentive offered to bring about desired behaviours must be considered – often this will be monetary. Gneezy et al. note that monetary incentives have a direct price effect and a psychological effect. Finally, policymakers must think about how the incentive is framed.
Providing a monetary incentive to bring about a desired change in behaviour might seem an obvious policy choice such as offering a monetary incentive to donate blood or install solar panels. Gneezy et al. point to reasons why the outcome might not be as obvious as first hoped. They suggest that in some cases, offering monetary incentives can ‘crowd out’ the desired behaviour. Offering a monetary incentive can change the perceptions of agents. People have intrinsic motivations – personal reasons for particular behaviours. Others have perceptions about the behaviour of others, for example, someone who donates blood might be seen by others as being ‘nice’. Social norms may also be affected, for example attitudes to smoking or the recycling of waste.
Gneezy et al. suggest that monetizing behaviour changes the psychology, and the psychology effect can be greater than the direct price effect. The price effect would suggest that if you pay someone to donate more blood, you should get more people donating blood. People who donate blood, however, might do so out of a personal conviction – they have intrinsic motivations. By offering monetary incentives, the perception of the donor and others might change so that they are not seen as being ‘nice’ any more but as being ‘mercenary’, and not motivated intrinsically but by extrinsic reward – greed, in other words. If the psychological effect outweighs the direct money effect, the result could be a reduction in the number of donors.
In the case of cutting smoking, the size of the money effect might be a factor. This chapter has raised the idea of rational people thinking at the margin. With smoking, the marginal decision to have one more cigarette imposes costs and benefits on the smoker – the benefit is the pleasure people get from smoking an additional cigarette, and the cost the (estimated) 11 minutes of their life that is cut as a result. The problem is that the marginal cost is not tangible and is likely to be outweighed by the marginal benefit (not to mention the addictive qualities of tobacco products). Over time, however, the total benefit of stopping smoking becomes much greater than the total cost. The incentive offered, therefore, must be such that it takes into account these marginal decisions, and it might be difficult to estimate the size of the incentive needed.
Other issues relating to incentives involve the trust between the principal and agent. If an incentive is provided, for example, this sends a message that the desired behaviour is not taking place. There may be a reason for this.
This might be that the desired behaviour is not attractive and/or is difficult to carry out. Incentives also send out a message that the principal does not trust the agent’s intrinsic motivation; for example, that people will not voluntarily give blood or recycle waste effectively. Some incentives may work to achieve the desired behaviour in the short term, but will this lead to the desired behaviour continuing in the long term when the incentive is removed?
Incentives might be affected by the way they are framed – how the wording or the benefits of the incentive are presented to the agent by the principal. Gneezy et al. use a very interesting example of this. Imagine a situation, they say, where you meet a person and develop a relationship. You want to provide that person with the incentive to have sex. The effect of the way the incentive is framed might have a considerable effect on the outcome. If, for example, you framed your ‘offer’ by saying ‘I would like to make love to you and to incentivize you to do so I will offer you €50,’ you might get a very different response to that if you framed it by saying: ‘I would like to make love to you –
I have bought you a bunch of red roses’ (the roses just happened to cost €50).
Finally, the cost effectiveness of incentives must be considered. Health authorities spend millions of euros across Europe on drugs to reduce blood pressure and cholesterol. Getting people to take more exercise can also help achieve the same result. What would be more cost effective and a more efficient allocation of resources? Providing incentives (assuming they work) to encourage people to exercise more by, for example, paying for gym membership, or spending that same money on drugs but not dealing with some of the underlying causes?

Critical Thinking Questions
1 Why should people need incentives to do ‘good’ things like donating blood or putting out more rubbish for recycling?
2 What is meant by the ‘principal–agent’ issue?
3 What might be the price and psychological effect if students were given a monetary incentive to attain top grades in their university exams?
4 Why might the size of a monetary incentive be an important factor in encouraging desired behaviour, and what side effects might arise if the size of an incentive were increased?
5 What is ‘framing’ and why might it be important in the way in which an incentive works? Refer to the need to increase the number of organ donors in your answer to this question.