Preferences differ, sometimes dramatically, between individuals. How much is a ticket to see a performance of the Bolshoi Ballet worth? Some people would be willing to pay a very high price, while others might prefer to stay home, even if tickets were free! Circumstances can change from day to day, even for a given individual. Alice, a ballet fan who usually would value the ticket at more than its price of $100, is invited to a party and suddenly becomes uninterested in attending the ballet. Now what is the ticket worth? If she knows a friend who would give her $40 for the ticket, it is worth at least that much. If she advertises the ticket on eBay and gets $60 for it, a higher value is created. But if someone who doesn’t know of the ticket would have been willing to pay even more, then a potential trade creating even more value is missed. If that particular performance is sold out, perhaps someone in town would be willing to pay $120. One thing is certain: The value of the ticket depends on several things, including who uses it and under what circumstances.
Economics recognizes that people can and do value goods differently. Mike may prefer to have a grass field rather than a parking lot next to his workplace and be willing to bear the cost of walking farther from his car each day. Kim, on the other hand, may prefer the parking lot and the shorter walk. As a science, economics does not place any inherent moral judgment or value on one person’s preferences over another’s-in economics all individuals’ preferences are counted equally. Because the subjective preferences of individuals differ, it is difficult for one person to know how much another will value an item. Think about how hard it is to know what would make a good gift for even a close friend or family member. Thus, arranging trades, or otherwise moving items to higher valued users and uses, is not a simple task. The entrepreneurial individual, who knows how to locate the right buyers and arranges for goods to flow to their highest valued use, can sometimes create huge increases in value from existing resources. In fact, people moving goods toward those who value them most and combining resources into goods that individuals value more highly is a primary source of economic progress.
Archive for July, 2010
The value of a good or service is subjective
July 8th, 2010Incentives matter-choice is influenced in a predictable way by changes in incentives
July 4th, 2010This is probably the most important guidepost in economic thinking. It is sometimes called the basic postulate of all economics. As the personal benefits from an option increase, a person will be more likely to choose it. On the other hand, as the personal costs associated with an option increase, a person will be less likely to choose it. This guidepost also applies to groups of people, and suggests that making an option more beneficial will predictably cause more of them to choose it. Similarly, making an option more costly will cause fewer of them to choose it.
This basic idea is a powerful tool because its usefulness is practically universal. Incentives affect behavior in virtually all aspects of our lives, ranging from market decisions about what to buy to political choices concerning for whom to vote. If beef prices rise, making beef consumption more expensive relative to other goods, consumers will be less likely to buy it. The “incentives matter” postulate also explains why a person would be unlikely to vote for a political candidate who, if elected, would raise taxes to fund a new government program he or she didn’t like very much.
Most errors in economic reasoning occur because people overlook this postulate or fail to apply it consistently. With economic applications generally focusing on people trying to satisfy material desires, casual observers often argue that incentives matter only in cases of human selfishness. This view is false. People are motivated by a variety of goals, some humanitarian and some selfish, and incentives matter equally in both. Even an unselfish individual would be more likely to attempt to rescue a drowning child from a threefoot swimming pool than the rapid currents approaching Niagara Falls. Similarly, people are more likely to give a needy person their hand-me-downs rather than their favorite new clothes.
It is clear that incentives, whether monetary or nonmonetary, matter in human decision making. People will be less likely to walk down a dark alleyway than a well-lit one; they will be more likely to take a job if it has good benefits and working conditions than if it doesn’t; and they will be more likely to bend down and pick up a quarter lying on the sidewalk than they will a penny. Even a person who normally bends down to pick up pennies on the sidewalk probably would be less likely to if late for an important appointment, or on a first date.
Just how far can we push the idea that incentives matter? If asked what would happen to the number of funerals performed in your town if the price of funerals rose, how would you respond? The “incentives matter” postulate predicts that the higher cost would reduce the number of funerals. While the same number of people will still die each year, the number of funerals performed will still fall as more people choose to be cremated or buried in cemeteries in other towns. Substitutes are everywhere-even substitutes for funerals.