Business, Community & Government

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.

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

Topics include: Applying Principle 1: People Take Advantage of Incentives • Applying Principle 2: Every Sale Is a Purchase • The Parable of the Babysitting Co-op • Good Economics Can Be Beautiful


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...

About the Instructor

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.

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Paul Krugman

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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