In 2016, Wells Fargo paid $185 million to settle a scandal in which employees had opened more than two million fake accounts in customers' names. The employees weren't acting out of malice — they were responding to aggressive sales quotas that rewarded account openings with bonuses and threatened termination for shortfalls. The incentive structure produced exactly the behavior it financially rewarded, regardless of what management claimed to want. Incentives don't care about intent.
In plain terms
An incentive is a factor — a price, a reward, a penalty, a regulation, a social norm — that changes the costs or benefits of a decision and thereby influences the choices a person or organization makes. In economics, incentives are the mechanism through which markets coordinate behavior: the price of gasoline incentivizes fuel efficiency; the minimum wage incentivizes employers to automate low-skill tasks; a carbon tax incentivizes emission reduction.
The Consumer Financial Protection Bureau studies how financial product incentives shape consumer borrowing and saving behavior — a direct application of the principle that incentive structures, not exhortations, determine outcomes in markets.
Why it works this way
Economic agents — people, firms, governments — respond to changes in the costs and benefits facing them. When an action becomes cheaper or more rewarding, people do more of it. When it becomes more costly or less rewarding, they do less. This is not greed or selfishness — it is the rational response to a changed environment, and it applies even to prosocial behavior: IRS data on charitable giving shows charitable donations rise when the tax deductibility of giving increases, because the tax code changes the after-tax cost of donating.
Perverse incentives are the most policy-relevant case. A hospital paid per procedure has an incentive to perform more procedures, not to improve patient health. A school evaluated on standardized test scores has an incentive to teach to the test, not to develop broad competency. Any system that measures and rewards a proxy for the real goal will optimize the proxy at the expense of the goal — a pattern so common it has a name: Goodhart's Law.
A real example
The U.S. Department of Labor's minimum wage research documents how a price floor on labor creates incentives for both workers (to supply more labor at higher wages) and employers (to substitute capital for labor, reduce hours, or raise prices). The incentive effects run in multiple directions simultaneously — which is why minimum wage policy debates are empirically contested rather than theoretically simple.
Why it matters
Every contract, law, and policy creates an incentive structure. Analyzing that structure — asking what behavior it rewards, what it penalizes, and what unintended responses it might produce — is the most important discipline in applied economics. The question is never only "what does this policy intend?" but "what does it incentivize?" Those two answers are often different, and the second one determines what actually happens.
