Ricardo’s theory of wages and profit
One application of incentives in economics can be found in David Ricardo’s theory of wages and profit. Ricardo, who was a political economist in late-eighteenth and early-nineteenth century England, is listed alongside Adam Smith as one of the key players in developing the field of economics.
Ricardo presented his theory of wages and profit with the goal of describing the means by which farmers and landlords negotiate rent. In order to pay their rent to their landlords, farmers allotted a portion of their produce to the landlords and kept the rest for themselves. Ricardo concluded that the most reasonable allotment would be for farmers to keep the amount of produce that could be procured from the worst plot of land being farmed and the surplus would be used to pay their rent.11
His reasoning was as follows: If the rent were so high that the farmer was left with less produce than could be obtained from the worst plot of land, it would not be worthwhile to continue renting from this landlord. Instead, the farmer would be better off renting land so bad that it was not being cultivated. The farmer could offer the landlord of this uncultivated land a very small amount of rent and, since it was not being rented up until that point, the landlord would still benefit from it. Alternatively, the farmer could request that the rent be lowered, which may lead the landlord to evict them and find another farmer to rent their land.12
Both scenarios illustrate the ways in which both farmers and landlords may be incentivized to improve their situation. The landlord may attempt to find someone new to whom they can rent land, who is willing to pay their high rent, while the farmer may try to find a new landlord from whom they can rent at a lower rate. Both are trying to boost their economic standing. The result of Ricardo’s theory was that all farmers in England made a similar income, which was approximately the amount that could be produced on the worst plot of land.
Incentives in health
Psychologists are interested in determining if incentives can be used to get people to stop engaging in unhealthy behaviors, like smoking, or to encourage them to engage in healthy behaviors, like exercise.
In order to assess the power of incentives, one study staged an intervention to help smokers kick the habit. All participants in the study attended five classes, with half the participants receiving $20 for each class they attended. The short term results of this intervention were promising: individuals who received the financial incentive were more likely to attend all the classes and give up smoking following the program. However, at a six month follow up, there was no significant difference in the number of people who quit smoking between those who received the incentive and those who did not.13 This suggests that financial incentives may not be as effective in the long term. That being said, there are instances when quitting smoking even just in the short term can be beneficial. For example, these types of interventions may be useful for individuals who are attempting to give up smoking while pregnant.14
When behaviors are intrinsically motivated, things can look different. In the realm of healthy behaviors, such as exercising regularly, one interesting finding revolves around the importance of habit formation. In a study conducted in 2009, participating university students were taught about the potential health benefits of exercise, then were split into three groups. The first was given no incentives to go to the gym, while participants in the second and third groups were promised $25 if they went to the gym at least once in the next week. In the next stage of the study, students in one of the two incentive groups were told that if they went to the gym at least eight times in the next four weeks, they would be granted an additional $100. The researchers recorded how frequently the students went to the gym before, during, and after the intervention. The key outcome of this study was that only students who were offered the $100 incentive were more likely to go to the gym during the course of the intervention and after the intervention had ended.
However, combining incentives with social networks can play a role, too. A similar study demonstrated that participants in the incentive condition were more likely to go to the gym frequently if they had more friends in the incentive condition than in the control condition, and less likely to attend the gym frequently if they had more friends who were not being incentivized. As you can see, incentives can help people develop healthy habits over time – such as the four-week period over which participants were incentivized to go to the gym. Once this habit has been formed, people may stick to it without the external incentive to do so, if it aligns with their goals or values (intrinsic motivation). Furthermore, social connections seem to enhance this effect, although more research is needed in this area.15