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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.


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.

I wasn't sure if this class from Paul Krugman would be enjoyable but was pleasantly surprised at how interesting the presentation of what could be considered dull subject matter became. Mr. Krugman humble approach to the topic and humor made this class very enjoyable. Thank you!

A wonderful crash course in economics and the breakdown of the thought process. Obviously no way to cover all of economics in a short class but the approach was excellent.

I really enjoyed this class. I learned a lot about the healthcare system.

Very informative. An interesting perspective.


Jonah O.

REVIEW: So the only way to get coupons is to babysit. In a babysit, you give coupons...hmm.... You have to save up or babysit to get more coupons. But everybody will want to do that, and they will not have anyone to babysit.


Would the farmer story remain similar if we don't assume an abundance of farmers? I guess here the fundamental assumption (and a reasonable one ) assumes less land and many farmers...I wonder though how the model will change if we modify that assumption

Alessandra D.

Concerning the balance of payments, there's a credit for every debit, so when Mexico imports a car from America, the investment in Mexico goes up by the same amount imports did. America is selling Mexico a car, and Mexico is selling America Mexican assets. How does this apply to countries with a shared currency? If someone in Italy imports a car from Germany, they are paying in Euro, which doesn't directly increase the investment in Italy.


At what point can you no longer print 'babysitting coupons' and end up with runaway 'babysitter' inflation?


Q: In the babysitting example, the thing that fixed the problem was to print more coupons. What would be the equivalent of 'printing more coupons' in a country recession?

Markus B.

7:30: Sorry, but the farmer story makes no sense to me: Why would the farmer (on the second lot) who only had to do the work for creating 4 bushels (in order to earn one) switch to working on the first lot, where he has to do the work for 6 bushels and still only earn one? This seems to be an oversimplification. Since it clearly takes more work to produce more, the farmers would prefer the worse lots over the better ones, if they got to keep exactly the same PLUS this also ignores that switching lots, moving your entire family to a different farm, etc. produces huge costs and inconveniences, so no one would move, just to get the exact same deal.--What am I missing?

Alban A.

Hey in the workbook the link to read the original great capitol hill baby sitting coop crisis doesn't work.

A fellow student

For the babysitting story: would it solve the problem by adding another mechanism, which is how many times minimum a couple needs to go out/babysit? I'm not sure if doing some math would figure out the right formula to prevent the "recession" situation......

A fellow student

For the US-China deficit: I wonder if people count those international students and property buyers who sent fortunes to the US economy?

A fellow student

For the farmer parable: it's used to explain the income distribution and what determines people's income level? What if for some work, people know that they are just getting paid by the lowest standard, thus they make less effort (within their talent and capabilities) which eventually harm the business?