People Respond to Incentives

An incentive is something ( such as the prospect of a punishment or a reward) that induces a person to act . Because rational people make decisions by comparing costs and benefits, they respond to incentives. Incentives are crucial to analyzing how markets work. For example, when the price of an apple rises,people decide to eat more pears and fewer apples because the cost of buying an apple is higher. At the same time, apple orchards decide to hire more workers and harvest more apples because the benefit of selling an apple is also higher. As we will see, the effect of a good's price on the behavior of buyers and sellers in a market-in this case, the market for apples-is crucial for understanding how the economy allocates scarce resources.