One of the most important principles concerning economics is the underlying assumption that people are rational and respond to incentives; or in other words, people are self-interested. We all weigh the costs and benefits of our choices and only make a decision when a choice has a greater benefit than its cost. Costs and benefits are not limited to dollar signs as time, emotions, and reputations amongst other factors come into consideration when making a rational decision.
We are all motivated by incentives as incentives are a representation of a rational decision. Incentives are at work all around us and Adam Smith explains that incentivizing others- often through money- is responsible for making available all the goods that we consume. In order to buy food from a farmer, we must make it be in his self-interest by giving him something in return for his crops. The power’s of incentives are immense and have led to society’s great innovations, whether it is the automobile or air conditioning. What is interesting about incentivizing self-interest is while at the same time an individual benefits society does too. This phenomenon is commonly referred to as the Invisible hand because the pursuit of our own self-interest results in society’s interest without any authority monitoring along the way.
Below, is the famous economist Milton Friedman explaining his take on the Invisible hand.
