The Economic Way of Thinking and Incentives

This set covers vocabulary and core concepts from the lecture on the economic way of thinking, focusing on incentives, optimization, and unintended consequences of public policies.

Economic way of thinking

A framework for understanding behavior that can be summarized by the four-word sentence: "people respond to incentives."

Economizing or Optimizing behavior

The governing principle of individual choices where a person compares the expected additional benefit and the expected additional cost of a decision.

Decision Rule Inequality

$$\text{expected additional benefit} \geq \text{expected additional cost}$$

Expected additional benefit

The additional gain an individual anticipates receiving from choosing a specific action.

Expected additional cost

The additional loss or sacrifice an individual anticipates from choosing a specific action.

Cobra Effect

An unintended consequence where offering a bounty for snakes led people to breed them because the expected additional benefit of breeding exceeded the expected additional cost.

Seat belt laws (Incentive Effect)

Legislation that lowers the expected additional cost of risky driving, which can tip the decision inequality in favor of driving faster or more recklessly.

Policy Evaluation

An economic superpower involving the evaluation of rules based on the incentives they create rather than their noble objectives or intent.

Institutions

Entities that set the "rules of the game," such as property rights, which influence choices by setting incentives.

Hoy No Circula

A pollution reduction scheme in Mexico City (meaning "no circulation today") that banned cars from driving on specific days based on their license plate numbers.

Three strike laws

Laws that substantially increase the prison sentence for a person convicted of a felony if they have previously been convicted of two or more violent crimes or serious felonies.

Third strike offense

Under California's three strike laws, a third conviction (even for a less severe offense like illegal possession) can make a person eligible for a sentence equivalent to that for murder.

Unintended consequence of three strike laws

An observed increase in murder rates, caused by the change in the relative incentive structure for criminals facing a life sentence on their third offense.