No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Two: Fundamentals of Economic Behavior 46 We’ve mentioned incentives above, and it’s probably time to expand on that concept. Incentives are simply carrots and sticks to motivate people to choose one behavior over another. We see incentives in action all the time in our individual lives. If you do well in school, you might get or maintain better scholarships, more freedoms from your parents, etc. If you misbehave at school, you might receive poor grades or get expelled. Incentives are both positive and negative, motivating you to behave a certain way. Good behavior leads to good rewards; poor behavior leads to poor rewards or even punishment. Incentives are very powerful, and if correctly designed, will almost always influence behavior to some degree. These incentives can be formal written rules such as speed limits, or informal social norms such as unacceptable public behavior that others might find gross or offensive. Economic incentives are just as powerful in guiding behavior. A common statement for public policy is: If you want more of something, subsidize it! If you want less of something, tax it! When we raise taxes on cigarettes, we provide a negative incentive (or sanction) to smoking. Less people will smoke. When we give a tax write off for charitable deductions, more people will give to charity, on the margin . It is important to note that not everyone will contribute more to charity because of tax write-offs; it is sufficient that there will be some people “on the margin” who are not sure whether they want to give to a charity or not. When they think about the tax-deductibility of their donation, that is what pushes them “over the hump” to decide to give. Policy decisions affect behavior of the marginal decision-makers—those who are “on the fence” about any particular issue and the policy pushes them in one direction or the other. EMERGENT ORDER Institutions help us plan, and more effectively dovetail our plans with those of others. As incentives help to reinforce positive behavior with good results while punishing negative behavior, we often see a most surprising result: individuals pursuing their own narrow self-interest often end up serving the common interest. Adam Smith famously referred to this as the invisible hand that guided private action to serve the public good. Smith noted that this unintentional service was often a far more effective way to serve the common good than those that claimed to serve the poor. invisible hand: the principle that individuals acting in their own self- interest will tend to act in a way that is socially beneficial, even though it was not part of their original intent WHY ARE INSTITUTIONS PROMOTING MORAL BEHAVIOR NECESSARY FOR FREE MARKETS? The basics of free markets are value creating exchanges, as we will see shortly. But for value creating exchanges to take place, a certain level of trust is necessary. What would happen to your purchases of Wendy’s hamburgers if some vendors didn’t clean their equipment to save money and a significant percentage of their customers died from E. coli? Or if you couldn’t trust your employer to pay the agreed to wages (James 5:4)? You wouldn’t buy many hamburgers or work for people who would cheat you. But if everyone was honest, then it gets easier to make trades. And institutions which promote moral behavior are therefore a contributor to economic growth!