INCENTIVES AND

MOTIVATIONS
INCENTIVES IN NEOCLASSICAL ECONOMICS
• Assumptions
• Well-informed and able to use information efficiently.
• Independent in two senses:
• atomistic – they do not look to others when deciding what to do;
• selfish – their utility is determined only by their own comforts.
• Rational maximizers:
• using information efficiently by applying mathematical tools to guide their behavior, so
their behavior is systematic and objectively determined, and immune from emotional
and sentimental forces, especially if these are associated with systematic biases in
decision-making → maximize utility and profits in monetary terms
• forward-looking in a systematic way, which involves discounting the future in ways which
are consistent over time so that it makes no difference whether looking one day ahead
or one decade ahead: their choices about future plans are consistent.
• Homogenous, all people behave in the same way (on average at least) so that
one model can capture everyone (on average at least).
 • Intrinsic motivation involves doing something
because it's personally rewarding to you.
• Extrinsic motivation involves doing something
because you want to earn a reward or avoid
EXTRINSIC punishment.
• Monetary incentives drive extrinsic motivation
VERSUS (motivation driven by external rewards) and
INTRINSIC undermine intrinsic motivations, including
internally-driven motivations such as curiosity,
MOTIVATIONS helpfulness and self-realization.
• Crowding-out of intrinsic effects undermines the
focus in standard economic theory on the
importance of monetary rewards and incentives.
SOCIAL MOTIVATIONS
• Our incentives and motivations are also determined
by our relationships with other people around us
• Behavioral economists address these debates about
the limits to our self-interest by building models
incorporating social preferences, sometimes called
other-regarding preferences
 • Based on “monotonicity” assumption
• 50% of proposers offer a lot more than zero
ULTIMATUM GAME • 20% of responders reject the offers (especially low
offers)
→ Responders desire to punish the proposer for
making an insultingly low offer

Player 2
• Given a fixed amount The Responder • Accept → both share
of money - $100 the offered amount
• Asked to offer player • Informed above the • Reject → get nothing
2 some propotion of offer
the sum – range from • Accept or Reject the
$1 to $100 offer

Player 1
Result
The Propose
DICTATOR GAME

Player 2
• Given a fixed amount The Responder • Self-interest
of money - $100 prediction
• Asked to offer player • Informed above the • Player 1 will offer as
2 some propotion of offer low as possible ($1)
the sum – range from • Force to accept
$1 to $100

Player 1
Result
The Propose
 • Inconsistent with the assumption
• Vast majority of player 1 make a transfer

TRUST GAMES (investment)

• Reflects unconditional kindness (altruism) or trust
• Social norms of generosity

STAGE 1 Player B
Prediction
• Given a fixed amount The Trustee • Accept the offer from
of money - $100 B
• Asked to offer player • Informed above the • Self-interest A: send
2 some propotion of offer nothing to B
the sum – range from • The offer is tripled • Self-interest B:
$0 to $100 • Asked to reciprocate reciprocate nothing to
to A A
Player A Player A
The Trustor STAGE 2 The Trustor
THIRD-PARTY PUNISHMENT GAME

• Given a fixed amount of

money - $100
Player B • Given a fixed amount of
money - $50 (using to
• Asked to offer player 2 • Informed above the offer punish A)
some propotion of the sum • Accept or Reject the offer • Can observe and punish A
– range from $0 to $100 • Every punishment point
assigned to A costs C 1
point and A 3 points

Player A Player C
PUBLIC GOODS GAMES
• A public good has the following two characteristics:
• It is non-rivalrous; its consumption by one person does not reduce
consumption by someone else.
• It is non-excludable; it is not possible to exclude someone from using
the good.

Community
• Asked to • Predict free-
contribute to a • These rider on others’
public good contributions contribution
are shared
among people
Players Purpose
 • Ultimatum games
• Offers above the prediction of the self-
interest hypothesis
• Rejections
• Positive transfers in the dictator game
• Disadvantageous counteroffers
• Trust games
• Positive relation between wages and
SUMMARY effort
• Wages far above the competitive level
• Many transfers in the trust game
• Third party punishment game
• Uninvolved third parties punish unfair
dictators and defectors
• Public good games
• Contributions higher than predicted by
self-interest hypothesis
• Conditional cooperation
• Punishment of free riders
 • Negative incentives can be motivating too
• Studies in behavioral economics and neuroeconomics
have shown that people are willing to pay to punish
norm violators.
• They also find that people who are initially cooperative,
PUNISHMENT will start to defect if they are not punished
AND • They begin by defining social norms as behavioral
COOPERATION regularities based on socially shared belief about how to
behave.
• Social norms are enforced via informal social sanctions
and these sanctions determine work effort, consumption
choices, common pool resources, as well as provision of
public goods. Social history is important, and people do
punish inappropriate behavior even when costly to
themselves
SOCIAL MOTIVATION THEORY

• Theories of utility are developed essentially to extend neoclassical

conceptions of utility
• Altruistic preferences cannot fully explain play in ultimatum
games, dictator games and solidarity games because needs of
others and reducing inequality are not necessarily primary goals.
BOLTON AND OCKENFELS’ EQUITY, RECIPROCITY AND
COMPETITION (ERC) MODEL
• Capture other-regarding preferences
• Assume narrow self-interest but with people balancing trade-offs between
their absolute pecuniary payoffs and relative payoffs
• Emphasis on narrow self-interest means that their model fits more neatly
with mainstream assumptions of rationality but they assert that their
motivation function can also connect different social preferences seen in
different contexts
• For example sometimes people exhibit social preferences for fairness;
other times they want to reciprocate and other times they want to
compete.
• So the ERC model can reconcile evidence about equity, reciprocity and
generosity with evidence about competitive self-interested behaviour,
allowing heterogeneous preferences to reflect differing motivations
INEQUITY AVERSION IN FEHR AND SCHMIDT’S FAIRNESS,
COMPETITION AND CO-OPERATION (FCC) MODEL
• Develops analysis of aversion to unequal outcomes within an experimental context.
• Analyse subjects’ responses to hypothetical dispute scenarios in which the experimental subject is either
acknowledged or snubbed by a hypothetical partner in a range of scenarios including non-business interactions with
a peer and business interactions between a customer and salesperson. Subjects were asked to grade their
satisfaction with the hypothetical solution.
• Then they used the fit of reported satisfactions to a range of social utility functions and found that a utility function
which incorporated discrepancies in the payoffs between the members of each pair, that is, a function incorporating
payoffs in which the experimental participant the subject got a better outcome than their partner, and payoffs in
which the participant’s outcome was worse than their partner’s, correlated well with reported satisfaction
• Capture the impacts on utility of what they describe as inequity aversion, that is, dislike of unequal outcomes. In this
model, utility is affected by payoff differentials between players. If a person has a smaller payoff than other players,
then this will lower their utility; and if they have a larger payoff then that will raise their utility
• two forms of inequity aversion:
• advantageous inequity aversion – inequity aversion experienced by people in a position of relative advantage;
• disadvantageous inequity aversion – inequity aversion experienced by people in a position of relative
disadvantage.
• For example, a banker who is unhappy about poverty is experiencing advantageous inequity aversion; a poor
person who is unhappy about bankers being rich is experiencing disadvantageous inequity aversion.
 CHOICE OVERLOAD
• Neoclassical utility theory
• People’s choices are constrained just by
monetary constraints – specifically prices,
income and wealth
• The standard model in economics focuses on the
importance of choice and implicitly it is assumed
that the more choices we have the better we will
be
• Behavioral economics
• Non-monetary, psychological/cognitive
constraints interact with some of the behavioral
incentives and motivations
• Cognitive constraints include choice overload
and information overload
• Psychological research has shown that too much
choice – choice overload – can be demotivating
• People perceive themselves to be overloaded
with choices will also depend on the timeframe
within which they must make their decisions