Thursday, April 9, 2009

People Respond Incentives, Apparently

There are a couple of interesting articles from recent issues of The Wall Street Journal that really make this clear. One speaks to current incentives, and one speaks about possible future incentives.

The current example illustrates how companies (in this case a large shipping firm) respond to the incentives revealed by prices. Everything from falling demand for service, to fuel prices, to canal fees becomes part of the decision matrix. One captain even advances his departure time because it will allow him to cruise at a slower speed, thus saving fuel. It's an interesting story and can be used with students to seek out the examples of cost-cutting, and to extend the ideas to how they are cutting costs at home - responding to the incentives inherent in the price mechanism.

Actually, one of the more interesting parts of the article was the revelation that, in certain circumstances, it was cheaper for the ships to travel to Asia around the tip of southern Africa rather than go through the Suez Canal.

The future example is in an opinion piece. The authors are concerned with a plan to tie Medicare payments to "quality metrics" for medical care. The idea seems logical and one designed to protect the patients, as well guarantee sound use of resources. But the incentive structure that's being proposed could have unintended consequences (see above post).

Regardless of which side of the health care debate you come down on, it is important to study the changes in incentives that result. Those changes can have significant positive consequences that are largely intended. (Otherwise, why would you change the policy?) But it can also have significant unintended negative consequences. My feeling is that much of the current health-care situation is due to the unintended consequences of previously developed policies.

The second article can be used with your students to discuss how incentives tied to performance can have negative consequences. (It seems to me that was part of what happened in the financial crisis.)

I look forward to your comments.

A number of blogs have picked up on The Wall Street Journal piece about Maersk shipping and have linked it to a recent act of piracy that affected one of Maersk's ships. One detail that isn't made clear is that the ship in question was NOT travelling from Asia to Europe or vice-versa like the ship mentioned in the earlier piece. This ship, according to reports, was sailing from Oman to deliver relief supplies to Ethiopia and Kenya - which accounts for what it was doing near to Somalia. (Actually all ships travelling through the Suez Canal would pass through Somali waters. Ships going around the Cape of Good Hope and bypassing Africa, could probably avoid Somali waters.

This post relates to the following Keystone Economic Principles:
1. We all make choices.
3. All choices have consequences.
4. Economic systems influence choices.
5. Incentives produce “predictable” responses.
8. Quantity and quality of available resources impact living standards.
9. Prices are determined by the market forces of supply and demand…and are constantly changing.

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