May 16, 2020

Issue #34 - Incentives 🐁

By Mental Models Weekly • Issue #35 • View online

“Don’t ask the barber if you need a haircut.”

Incentives is one of the reasons this proverb holds true.

Incentives is another simple yet big idea that’s important in psychology and both classic and behavioral economics. It’s well worth keeping top of mind!

What are incentives?

Everyone is probably familiar with what an incentive is - it’s a thing that motivates or encourages someone to do something.

Here are two great examples that illustrate the importance of incentives very memorably.

First here’s Charlie Munger’s favorite example:

One of my favorite cases about the power of incentives is the Federal Express case. The heart and soul of the integrity of the system is that all the packages have to be shifted rapidly in one central location each night. And the system has no integrity if the whole shift can’t be done fast. And Federal Express had one hell of a time getting the thing to work. And they tried moral suasion, they tried everything in the world, and finally somebody got the happy thought that they were paying the night shift by the hour, and that maybe if they paid them by the shift, the system would work better. And lo and behold, that solution worked.

- Charlie Munger, The Psychology of Human Misjudgment

Here’s my favorite example:

There was a problem with mice on campus. The solution for exterminating the mice was to pay students $1 for every dead mouse they delivered. It worked! Until the students began breeding mice in order to make more money…

- Peter Bevelin, Seeking Wisdom

Why is this interesting?

Incentives are a core driver of behavior and can be extremely powerful! They are particularly obvious at school and at work, with things like grades and remuneration - but they also drive behavior in our personal lives too. It’s also interesting to consider political systems and how the short democratic election cycle doesn’t always incentivize long term planning - in fact it’s often the complete opposite.

Once you start looking for the incentives, you’ll see them everywhere!

I’ll leave you with Munger’s recommendation:

“'Never, ever, think about something else when you should be thinking about the power of incentives.“

Photo by Ricky Kharawala

Want to go deeper?

💎If you love a little latin then remember this gem - “cui bono?”. It means “who benefits?” It’s meant in relation to crime - suggesting the that perpetrator is likely to be the suspect that benefits from the crime. But I think it’s useful one keep in mind to reverse-engineer incentives in a situation!

📖 If you like the Charlie Munger stuff, then the classic Poor Charlie’s Almanack is full of wisdom, as is Peter Bevelin’s Seeking Wisdom

🎧 The Psychology of Human Misjudgment speech from Charlie Munger is well worth your time