An incentive is anything that prompts an individual to act in a certain manner.
Higher gas prices may provide the incentive to change our behavior. Economists assume people respond to incentives. An incentive prompts an individual to act in a certain way. Parents often try to incentivize their children to behave as the parents want. Mom and Dad’s offer to pay their teenager, Joe, an allowance of $30 a week to take out the trash and cut the lawn is an incentive to get Joe to behave as they want. Joe has a choice. He will be paid if he does his chores. If he does not do his chores, he will not receive his allowance, and he will disappoint his parents. Businesses also use incentives for their employees. Rewards or bonuses encourage employees to work hard and reach certain goals. An offer with a higher salary may act as an incentive to switch jobs.
Substitute options that fulfill a consumer’s needs may also provide an incentive to switch products if the price of a particular good increases. Economists assume that a consumer would choose the substitute if it is the more attractive option. For example, commuters may choose to carpool or use mass transit if the price of gasoline increases.
Economists ask many questions related to human behavior in response to economic incentives, such as: How will people respond to a tax increase? How will spending patterns change with an increase in income? How will an increase in interest rates impact a business’s decision to expand?