 The study of incentives is one of the central topics in microeconomics, incentives to work hard, to produce quality products, to study, to invest, to save, etc. How to design institutions that provide good incentives for economic agents has been a central question of economics. Behind this, though, is the idea of motivation. What motivation do economic agents operate under? In this module, we will be presenting two very different frameworks for understanding agents' motives and associated incentive systems. We'll look at the model of incentive theory that is central to standard economics, and then go on to talk about the more complex model of intrinsic motives and choice architecture that is emerging out of behavioral economics. The motivation of economic agents derives from the needs, desires and aspirations that they are trying to fulfill. These different types of needs are typically structured through the use of a model called Maslow's hierarchy, that fundamentally divides them into primary needs and secondary needs. Primary needs are physiological in nature. They include such things as food, water, shelter, sleep and so on. Secondary needs are internal states, like the desire for power, achievement, belonging, opportunities for advancement, relations with work colleagues, input in decision making etc. Peoples and society's needs can change over time, as agents move on to new ones that become more intensified and important to them. Motives are the reason or reasons one has for acting or behaving in a particular way. It accounts for the direction, level and persistence of a person's resource expenditure In performing an activity or trying to achieve some end, motives are divided into two different kind, intrinsic and extrinsic. Extrinsic motives always have an end, a locus of desire and the process is just a means for getting there. Intrinsic motives do not necessarily have a final point of design, they are more process orientated, the end value is the process. A central question then within economics is how to create systems for aligning agents behaviour with those of the organisation or society. From driving too fast, to smoking, to work apathy, to lack of health insurance, economists, business management and policy makers spend a lot of their time thinking about this question and there are really just two ways to do this, either we use direct incentives or we alter the context within which agents are acting. Behavioral economics focuses on this latter solution, while standard economics focuses on the former which is called incentive theory. The basic premise of standard economics is that people respond to incentives, the theory of incentives is one of the major theories of motivation and suggests that behaviour is motivated by a desire for reinforcement or incentives. In contrast with other theories that might suggest we are pushed into action by internal drives, incentive theory instead suggests that we are pulled into action by outside incentives. According to this view, people are pulled towards behaviour that offers positive incentives and pushed away from behaviour associated with negative incentives. In other words, differences in behaviour from one person to another or from one situation to another can be traced back to the incentives available and the value a person placed on those incentives. The most common incentive would be a reward, rewards can be tangible or intangible and is presented generally after the occurrence of the action or behaviour that one is trying to correct or cause to happen again. This is done by associating positive meaning to the behaviour or action. Studies show that if the person receives the reward immediately, the effect is greater and decreases as delay lengthens. A combination of repetitive actions and rewards can cause an action to become habitual. This model has both its achievements and limitations. Incentive theory will give us a nice closed form model with direct linear cause and effect relations. They are very well suited to a top down form of management because extrinsic incentives are designed to give compliance, they are explicit and directly trying to alter agents behaviour according to the instructions of some managing body. Incentive systems have to be well designed, aligned with the interests of the agents in the system and the desired outcomes. Human beings are both finite and creative. That means that the people offering incentives are often unable to predict all of the ways that people will respond to them. Thus imperfect knowledge and unintended consequences can often make incentives much more complex than the people offering them originally expected and can lead either to unexpected windfalls or to disasters produced by unintentional distorted incentives. Added to this direct incentives may have a crowding out effect. If we only take into account one form of value we may try to optimise it at the expense of others with the overall throughput becoming suboptimal. Extrinsic incentive systems work well when there is a clear set of steps and a clear well defined expected outcome or goal but they only really work for analytical processes as they narrow our focus and concentrate our mind. Extrinsic incentives only work as long as the task involves only rudimentary mechanical tasks, simple algorithmic operations. Research has shown that when tasks become more complex that is as soon as the task involves some form of cognitive skill, creative skills or conceptual capabilities Extrinsic incentives were no longer effective and actually led to a poorer performance. This theory of management has been the default since the industrial age. This system has been the motivational structure for making people work throughout the 19th and 20th century. It is a core part of the whole industrial age capitalist model and the dichotomy between work and leisure but the post industrial economic environment we're moving into requires a new skill set involving entrepreneurship, cognitive capabilities, innovation and self-engagement. In this economy people's needs and motive structures are more complex. It is an economy where people are connected and feel motivated by forming part of networks that give them different value through social media, collaborative consumption, peer production, creative commons, open source and so on. All of these go beyond our traditional understanding of why people render professional services and this necessitates a more complex non-linear model that looks at the whole context within which agents are embedded in making their decisions. By incorporating a wider spectrum of motives and values, behavioral economics has developed a very different model. Within this paradigm we're thinking about how the broader context affects the choices that agents are making. We're looking at the physical, social and cultural networks of connections that the agents make choices within and how these different networks can add or subtract value from the motives of the agents in order to alter them. For example in a purely physical context, behavioral economics looks at how choices are arranged within space such as the layout of a city where plentiful open spaces make walking a more desirable mode of transport than other options or in a canteen restaurant for example where there's a choice where we place the items. We might put the healthy food at the entrance making it more accessible than other options. These choices that are the easiest option due to their spatial location are examples of attractor states. Being the easiest options they are a default, they attract users to adopt this choice. This is an example of what is called a nudge, a small influence within the environment that attracts our attention and influences the behavior that we make. Of course marketing has been using nudge theory for a long time in the layout of shops or the placement of products and catalogs but because marketing is largely about creating a context for influencing people's choices it is never really fitted in with standard economic theory. The social context within which choices are made is just as important as the physical. With the advent of social networking the social dimension has become much more important within economics both in work and consumption. By simply connecting people and making social information available this can strongly influence people's choices and provide motivation through a social context. Intrinsic motives are self-directional, they can be best fostered by simply giving them space to develop that is to say not crowding them out with incentive systems. You see some companies like Google who instead of offering an incentive to employees for coming up with new innovations they simply give the employees a day off every week to explore their interests as directed by intrinsic motives. By so doing they are simply not crowding out the intrinsic motives. Choice architecture is another outgrowth from behavioral economics which deals with the design of different ways in which choices can be presented to consumers and the impact of these presentations on consumer decision making. For example the number of choices presented, how we arrange those choices or which one is the default option. An important question here is how do we frame those choices? When we set a car do we tell prospective buyers the amount of fuel to run the car or the amount of money to run the car? Although they both relate to the same underlining piece of information it has been shown that people often make different decisions based on different ways that the information has been framed. Choice architecture is built on our understanding of people as non-rational agents and how they use all sorts of shortcuts to cope when making difficult decisions. In this short module we've been talking about incentive systems within economics. We firstly talked about how different kinds of needs create different motivational structures. We looked at the standard approach to influencing people's choices towards desired social outcomes through incentive theory which suggests that agents are pulled into action by outside incentives and by altering the payoffs associated with different choices we can alter their motivation. Inversely behavioral economics built on this idea of agents as non-rational actors tries to understand how people act in the real world, looking more at internal motives and the set of environmental conditions that influence those motives.