Question

A firm is considering two policies to increase worker output. The first policy would involve an increased wage described as an incentive for workers to increase their effort. The second policy is to announce a voluntary bonus for those workers whose effort is deemed to be extraordinary. Using insights from behavioral economics, which policy do you believe will be the more effective?

Short answer

According to insights from behavioral economics, the more effective policy is likely to be the second one: offering a voluntary bonus for extraordinary work. It capitalizes on behavioral insights like prospect theory and competition among workers.

Step-by-step solution

Analyze the first policy

The first policy being considered involves an increased wage as an incentive for workers. On the surface, this seems like a good plan. People generally work to earn money, and knowing that they could earn more might motivate them to work harder. However, it's worth noting that this approach might lose effectiveness over time. Assuming the increase is not massive, workers could eventually start viewing the raised salary as the new normal, causing the motivation to wane.

Analyze the second policy

The second policy involves providing a voluntary bonus to those workers who put in 'extraordinary' effort. This approach builds on several psychological factors. One is the prospect theory, which posits that people value a gain that is seen as a potential more highly than an actual gain. Secondly, the bonus creates an element of competition which can also act as motivation. Finally, the bonus, being 'extraordinary', is seen as a reward for effort beyond the standard, which can make the workers feel valued and appreciated.

Compare the policies

Comparatively, though both policies have possible positives, the second policy seems to have more potential to increase worker output. It capitalizes on behavioral insights like prospect theory and takes advantage of the competitive spirits. Of course, overall effectiveness could still depend on the particular situation and people involved.

Key concepts

Incentive Structures

Incentive structures refer to the systems that organizations use to motivate their employees. These structures can include both financial and non-financial incentives.
The goal is to encourage behaviors that align with the company’s objectives.
For financial incentives, increased wages serve as a direct method to enhance output. More money often means more motivation. However, there's a risk that this can lose its effectiveness if the increase is perceived as just the new baseline salary. Workers might initially work harder for a raise. But once they receive it, their effort could plateau.
On the other hand, non-financial incentives, like recognition and development opportunities, could also play a crucial role. For example:

• Providing opportunities for skill development.
• Recognizing employees in company meetings.
• Flexible working hours as personal incentives.

These non-financial incentives can be very effective as they often meet intrinsic motivational needs, such as the need for personal growth and achievement.

Prospect Theory

Prospect theory is a behavioral economic theory introduced by Daniel Kahneman and Amos Tversky.
It describes how people make choices in scenarios involving risks and uncertainties. According to prospect theory, individuals evaluate potential gains and losses differently. They typically prefer to avoid losses rather than acquiring equivalent gains. For instance, losing $100 feels worse than gaining $100 feels good.
In the context of workplace incentives, this theory suggests that offering a potential bonus can be more motivating than a certainty of a salary increase. Workers might be driven by the allure of what they 'could' gain if they exert extraordinary effort. This is because the potential for a bonus aligns with both their competitive nature and the natural inclination to favor potential gains.
Including elements like escalating bonuses to increase the perceived potential gain can further enhance motivation. For example:

• Tiered bonuses depending on levels of output beyond normal expectations.
• Public recognition tied with financial incentives for top performers.

These features can create a more engaging and dynamic work environment.

Workplace Motivation

Workplace motivation is the internal drive that compels individuals to achieve work-related goals.
It's influenced by various factors including incentives, leadership, and work culture. Several motivational theories exist, but one common element is that motivation often requires both intrinsic and extrinsic factors. Intrinsic motivation comes from within, such as self-satisfaction and pride in one's work. In contrast, extrinsic motivation comes from external rewards, like pay raises and bonuses.
Improving workplace motivation involves creating a balanced environment that nurtures both types of motivation:

• Promote a culture of recognition and appreciation.
• Encourage skill development and career advancement opportunities.
• Set clear, achievable goals and provide feedback.

Effective workplace motivation not only enhances productivity but also leads to higher job satisfaction and lower turnover rates. In the example of the firm's policies, assessing how they impact both intrinsic and extrinsic motivation will determine their long-term success in increasing worker output.