Business, Politics & Society

Two Fundamental Principles of Economics

Paul Krugman

Lesson time 7:40 min

First—people respond to incentives. Second—each transaction has an equal give and take. Paul breaks down economic thinking into two main principles and teaches you the intricacies of each.

Paul Krugman
Teaches Economics and Society
Nobel Prize-winning economist Paul Krugman teaches you the economic theories that drive history, policy, and help explain the world around you.
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What inspires average people to work harder, push for more, and achieve goals? Sometimes, that inspiration comes from within. But other times, incentives can help motivate people to perform to the best of their abilities. In the most general terms, incentives are things that motivate a person to do something. However, when we’re talking about economic incentives, the definition becomes a bit narrower. Economic incentives are financial motivations for people to take certain actions. There are two types of incentives: Extrinsic Intrinsic Extrinsic incentives encompass receiving a reward or avoiding punishment. Economic incentives are extrinsic motivators, in which a reward, like money, will motivate someone to accomplish a goal or task. In contrast, intrinsic motivation is when a person is motivated to do something for its own sake, without an outside pressure or reward. It’s that feeling of personal fulfillment and satisfaction that people get from doing certain things, like learning a new skill just for the fun of it. Common Types of Economic Incentives The most common type of economic incentive system is payroll: A paycheck motivates people to go to work. Here are five more examples of common economic incentives: 1) Tax Incentives Tax incentives—also called “tax benefits”—are reductions in tax that the government makes in order to encourage spending in a certain area. Tax incentives are often cited as a great way to encourage economic development. So, for example, a common individual tax exemption in the United States is the mortgage interest deduction, which makes it so money paid toward mortgage interest isn’t counted as taxable income. This incentivizes people to buy property. An example of a corporate tax incentive is a government giving a major company tax breaks in exchange for them building an office or plant in their city. This type of special tax incentive stimulates the economy in that area by empowering the company to provide jobs as well as make goods or services available for purchase. 2) Financial Incentives A financial incentive is a broader term that encompasses any monetary benefit given to a consumer, employer, corporation, or organization in order to incentivize them to do something they might not otherwise do. For employees, a financial incentive might be stock options or commissions that encourage certain types of work (just think of salespeople whose commission is considered a sales incentive). For customers, an example of a financial incentive is a “discount,” like a buy-one-get-one sale which encourages more spending under the guise of saving. 3) Subsidies Subsidies are governmental incentive programs that provide set amounts of money to businesses in order to help them grow. Agricultural subsidies are common in the United States, with the federal government giving farmers billions of dollars both to farm more of certain products and to reduce their outputs in times of sur...

Think like an economist

For Nobel Prize-winner Paul Krugman, economics is not a set of answers—it’s a way of understanding the world. In his economics MasterClass, Paul teaches you the principles that shape political and social issues, including access to health care, the tax debate, globalization, and political polarization. Heighten your ability to read between the lines and decipher the underlying economics at play.


Students give MasterClass an average rating of 4.7 out of 5 stars.

Dear Paul, I learned how important it is to learn economics. By better comprehending how people and money moves around the world. We can make better governments that are more humane and compassionate in the World. Thank You! Your Friend Hoc Ly! :D CEO, President, Kind Funny Friend NIGHTHOC ENTERTAINMENT, INCOPORATED! :D NIGHTHOCFILMS@GMAIL.COM :D

Great class. Was a good refresher for me and I love reading Paul's column in the Times.

Outstanding -- the instructor and the class and the online medium --- good photos, nice interface...

A very good overview of how the economy works! I would like to see a masterclass class that goes into more detail on each of the topics offered here.


A fellow student

Economics is about people - I would like to share when this struck home to me. I am a high school teacher of economics (IB) and students have to make commentaries on contemprary news articles. Some years ago one student was constructing a commentary on market failure based on a powdered milk scandal where baby milk was being imported into the US that was not pure powdered milk (country name witheld). The weight had been supplemented by non-milk powder (lesson on incentives for producers here but that is another story) which was causing sickness in babies. My student was using diagrams and concepts on market failure in their commentary and they asked me to review it - I was shocked by the abstract way it was written - all about curves and benefits and costs and equilibrium being below the social optimum but nothing about the poor babies. Yes we too often forget that economics is first about people.

A fellow student

I might be reading too much into the farmer story but if looks a bit flawed to me! For instance, what incentive does a farmer have to work on another land if they are going to be paid exactly the same amount? Moving is not a zero cost proposition, therefore the owner of the good land has to offer at least a bit more to incentives other farmers to move. That may, in turn, create an upward pressure on “wages” for other farmers working on other lands. On the flip side, if we assume there are unemployed farmers in this scenario. That creates a downward pressure on the wages as there will always be farmers who will be willing to work for a little less. How do these factor play into the model?

Tapan P.

The too many coupons... if everyone has a lot then people will just want more, just scaled up in numbers? They'd have to babysit more- so they'd also want more tickets.

A fellow student

Following up on my previous comment. The other day, a journalist asked a former Minister of Economy in a developing Country ( The former Minister is a self described marxist), that if it s true that emission does not generate inflation, and as he authoritatively answer yes, the journalist followed up with a recommendation... "Then why don't we stop collecting taxes altogether and finance all government's expenses through emission? I found it hilarious, how something tested to the extreme, sounds so silly...I would add too, why don't let people print their own coupons, without any restrictions...haha

A fellow student

In the case of the "Baby sitter's Co-Op", it is clear that too few coupons would not let the process flow normally, but I would like to have a clearer explanation of what happens if there are TOO MANY coupons...Coming from a Country where governments resorted to printing "coupons" (currency( like mad to get out of recessions, and seeing that the REAL result after short lived spikes in the economy, was a terrible, devastating, inflationary process, that in two cases ended in HYPERINFLATION, I am a little skeptical of this easy "solution". Any comments?

A fellow student

Very interesting. I liked how the concept of balancing was explained. Nevertheless, balance does not mean good, does it? Some of this economic balance could have unintended consequences that are very detrimental for a particular society... In other words, if you are responsible for the future of a given Country, ( not for a uthopic Global Society)it does not matter how well the accountants can do their job, but what are the consequences for your People. If you keep doing away with your jobs to other Countries, and they buy your debt, or other assets ( mainly Real Estate), the accounts will balance for a time, but after you sold all your assets and they collect on your debt, you are going to be Bankrupt as a Country, as you will have no way to repay said debt. I understand it is difficult to grasp the concept of the USA going bankrupt, but the formula has been tried before, and disaster happened in places like Argentina (twice) and Venezuela...

Cynthia H.

Major BREAKTHROUGH! The graphic design animations - make SO MUCH MORE SENSE than just hearing an instructor at the chalkboard. This is a major light switch going ON! Wow! I took Economics back in college - had a difficult time with it because the instructor was from another country and I was having to listen carefully - and overcome a communication issue. The principles that he is teaching are incredibly important. Everyone should understand more about this - because our entire financial awareness could be greatly improved upon... if people really understood what he is saying!

Sagnik P.

The links on the last page of the PDF don't seem to be working. These links point to Ricardo's work and Jodi Begg's rendering of circular flow model.


I would like to point out that the "every sale is a purchase" principle does not apply to fractional reserve banking system.


The lesson is good. But I am unable to download the lesson pdf. Can someone help me with that?