The Role of Incentive in Economic Activity

An incentive is a reward that encourages an individual, firm or other economic unit to take a particular course of action.

Incentives help to motivate many different types of economic behavior. For example, a profit acts as an incentive to supply more of a product. Bonuses act as an incentive for city bankers to work harder or to achieve better results.

If incentives can be employed to encourage certain types of activity then penalties (negative incentives) can be used to discourage other activities. A tax on pollution might discourage businesses from emitting harmful waste into water or into the air.