Lesson 3: Incentives Matter

Concepts:
  • People respond to incentives.
  • Entrepreneur
  • Innovation
  • Profit
  • Productivity
  • Competition
Content Standards and Benchmarks (4 and 14):

Standard 4: People respond predictably to positive and negative incentives.

Benchmarks:

  • Rewards are positive incentives that make people better off.
  • Penalties are negative incentives that make people worse off.
  • Both positive and negative incentives affect people’s choices and behavior.
  • People’s views of rewards and penalties differ because people have different values. Therefore, an incentive can influence different individuals in different ways.
  • Responses to incentives are predictable because people usually pursue their self-interest.
  • Changes in incentives cause people to change their behavior in predictable ways.
  • Incentives can be monetary or non-monetary.
  • Acting as consumers, producers, workers, savers, investors, and citizens, people respond to incentives in order to allocate their scarce resources in ways that provide the highest possible returns to them.

Standard 14: Entrepreneurs are people who take the risks of organizing productive resources to make goods and services. Profit is an important incentive that leads entrepreneurs to accept the risks of business failure.

Benchmarks:

  • Entrepreneurs are individuals who are willing to take risks in order to develop new products and start new businesses. They recognize opportunities, enjoy working for themselves, and accept challenges.
  • An invention is a new product. Innovation is the introduction of an invention into a use that has economic value.
  • Entrepreneurs often are innovative. They attempt to solve problems by developing and marketing new or improved products.
  • Entrepreneurs compare the expected benefits of entering a new enterprise with the expected costs.
  • Entrepreneurs accept the risks in organizing resources to produce goods and services and they hope to earn profits.
  • Entrepreneurial decisions are influenced by government tax and regulatory policies.
Lesson Theme:

The legendary inefficiency of productive efforts and the seemingly perverse behavior of firms in the former Soviet Union can be explained by examining the incentives faced by the managers of those enterprises, and by recognizing how those incentives differed from incentives faced by workers and planners.

Key Points:
  1. Review: The concepts of opportunity cost and markets are also useful tools when looking at the firm in the Soviet economy.
    • Like officials in the planning bureaucracy, managers were confronted by scarcity, and made choices that engendered opportunity costs.
    • Managers of firms also faced, often more directly than the planners, the problem of missing markets and the lack of information.
    • Added to the concepts of scarcity, choice, cost, and markets, the economic concept of incentives is a useful tool for analyzing the sources of failure at the next level of the Soviet economy, the level of the firm where actual production of goods and services took place.
    • In short, we can explain the seemingly inexplicable behavior of Soviet firms by understanding that the system failed to “get the incentives right.”
      • The central government planners ignored the incentives that stem from people’s attention to their self interest.
      • The economic concept of incentives is a powerful tool for explaining human behavior.
      • Incentives are rewards or penalties for behavior.
      • Incentives can be either positive or negative, and can thus encourage or discourage a particular action.
    • A fundamental principle of economic analysis is that “People respond to incentives.”
      • In market based economies, prices send signals that act as incentives to buyers and sellers, changing their behavior – that is, the amount of a good or service they are willing to purchase or to offer for sale.
        • The popularity of “Beanie Babies” and the price they sell for has sent a message to other producers to make stuffed toys that are similar to “Beanie Babies.”
        • When coffee prices rise rapidly, many consumers choose to drink less coffee by substituting some other drink or by simply not drinking as much.
  2. Market based economies utilize the power of profit as an incentive.
    • Profit motivates entrepreneurs to accept the risk of acquiring and organizing resources to seek market opportunities.
      • The entrepreneur takes whatever profit or loss results from an enterprise.
      • (This claim on the residual – the profit or loss – leads to the entrepreneur sometimes being referred to as the “residual claimant.”)
    • The entrepreneur’s desire to avoid loss and make profit provides an incentive to engage in 2 useful behaviors:
      • to innovate in order to reduce the cost of providing goods and services; and
      • to improve product quality and service.
    • The economy of the former Soviet Union substituted managers for entrepreneurs and quota-based systems of incentives for profit; the result was a system biased against the innovative and cost-reducing strategies that are key to the success of western economies.
  3. Conceptually, Soviet firms and farms were parallel structures to western enterprises.
    • They were nominally decentralized.
    • They employed labor and purchased raw materials in order to produce output.
    • However, the constraints of limited raw materials that a Soviet factory manager faced and the payoffs that determined his choices – output targets instead of profits – differed in important ways from those facing his American counterpart.
      • Consequently, the dynamic of market economies that leads to cost-cutting production techniques and the introduction of innovations was missing in the Soviet Union.
  4. Quotas – output targets – rather than profit motivated the Soviet factory manager.
    • Incentives were geared primarily toward achieving the quantitative output targets set by the central planners and the ministries.
      • Managers were rewarded solely on their ability to reach the production targets.
    • The emphasis on output rather than cost led to risk avoidance on the part of managers.
      • Innovation is a risk, and was studiously avoided by managers.
      • There were no incentives for them to engage in risk-taking.
    • Maintaining the status quo was generally the safest strategy given the incentive structure facing the factory manager.
      • Central planners had little knowledge of plant processes and tended to set targets primarily by observing a firm’s production level in the previous planning period.
    • Missed targets meant no managerial bonuses, and surpassing targets caused quotas to be raised for the next year.
      • Production goals and output quotas dampened managerial enthusiasm for introducing new products and production techniques.
      • Change was costly; both in terms of the risk of failure and in terms of the costs in time to train workers in new methods of production.
      • At very high cost, even to the point of fabricating their own replacement parts, enterprise managers were more apt to repair or even rebuild an old machine rather than introduce a more complicated and possibly more efficient one because the installation and training time might extend beyond the quota period.
    • Since managers were rewarded for not rocking the boat, they tried to protect themselves from unforeseen contingencies.
      • This was done by building up reserves of spare parts and special items, padding payrolls, storing up inventories of key inputs and by building slack into targets.
    • The economy gradually built up more and more unused resources throughout the system and increased waste.
      • Because of soft budget constraints and the consequent ease of acquiring financial funds (to be covered in point #6), this went unchecked.
  5. In addition to shifting the emphasis from profit to output, the incentive system facing the enterprise manager in the Soviet Union reflected two perverse arrangements: the soft budget constraint and the ratchet.
    • The soft budget constraint refers to the practice of allowing an enterprise to exceed its budget for production inputs if the manager could convince planners that without more resources, the factory would be unable to reach its output targets.
      • This is much like a child having his allowance increased every time he overspends.
      • Thus, managers had little incentive to reduce cost or adopt cost-saving innovations.
      • Conversely, industrial authorities at the ministerial level tended to confiscate unanticipated surpluses (revenues) that showed up in a factory’s accounts.
      • The result was that managers saw no benefit in overfilling their quotas and tended to hide the true productive capacity of their plants.
    • The ratchet, or practice of overstating needs for raw materials, also resulted from the almost exclusive focus on output targets.
      • Because resources were allocated on the basis of cost, managers had incentives to supply biased information to the overseeing ministry, which, in turn, had an incentive to ratchet up cost figures before passing them along to central planners.
      • The manager benefited by overstating costs so that he could obtain extra resources.
      • Similarly, managers tended to employ excess workers as insurance against the possibility of increased production targets.
  6. The result of this perverse system of incentives is well-documented in the stagnation, inefficiency, and corruption which characterized the Soviet economy.
    • Stagnation: Emphasis on output led to risk avoidance and a dearth of research and innovation at the level of the firm, which slowed modernization.
      • Separate ministries for research and innovation existed, but they were independent of specific production processes.
      • Research was undertaken for its own sake and not for its application to cost-cutting technologies.
    • This resulted in inefficiency, constant shortages, and misallocation of resources.
      • Outdated technologies were standard as were breakdowns in production processes.
      • Because targets were stated in terms of finished output, there were chronic shortages of spare parts.
      • The results were often work slow-downs or stoppages in other production sectors. It was not uncommon to see tractors sitting idle, waiting weeks for spare parts, while fields were tilled by hand.
    • Corruption: Bribes to allocators to gain access to supplies increasingly became an accepted practice, and most productive enterprises employed individuals in the full-time task of securing additional resources in illegal secondary markets.
      • One consequence was a proliferation of channels of economic and political monitoring created in recognition of the potential for diversion of resources.
      • This was costly not only in terms of lost efficiency, trust, and higher transaction costs, but also in terms of freedom and it made the task of planning even more difficult.
Conclusion:

Compared to a market-based firm, the behavior of the Soviet firm was perverse. The explanation of this behavior has little to do with the character of the individuals involved and everything to do with the incentives embodied in the system. Competitive markets reward firms for good performance with profits and usually penalizes poor performance with reduced profits or losses. The Soviet ministry, on the other hand, penalized managers for any disruptions and rewarded them for meeting targets. In the end, the manager who was most effective at hoarding resources, and was therefore the least efficient, received the rewards. Economic planners, producers, distributors, and other agents lost credibility.

Activity:  Why Would Anyone DO That? – Incentives Matter

Demonstration Video

Lesson Overview:

Five vignettes describe seemingly stupid or illogical behavior on the part of Soviet producers and consumers. With the help of some hints to direct their thinking, students identify the operative incentives, explain how those incentives led to the resulting human behavior, and propose changes in incentives that would modify behavior.

Economic Concept:
  • People respond to incentives.
Economics Content Standards:

Standard 4: People respond predictably to positive and negative incentives.

Benchmarks:

  • Both positive and negative incentives affect people’s choices and behavior.
  • People’s views of rewards and penalties differ because people have different values. Therefore, an incentive can influence different individuals in different ways.
  • Responses to incentives are predictable because people usually pursue their self-interest.
  • Changes in incentives cause people to change their behavior in predictable ways.
  • Incentives can be monetary or non-monetary.
  • Acting as consumers, producers, workers, savers, investors, and citizens, people respond to incentives in order to allocate their scarce resources in ways that provide the highest possible returns to them.
Materials:
  • Student Handout – “Perverse Incentives” (copy each scenario on a separate sheet of paper)
Time required:
  • 1-2 class periods
Assessment:

Working with a partner, compare and contrast the incentives that operate in private school and public school classrooms.

  • Identify the incentives for:
    • teachers
    • students
    • parents
  • What are the “output targets?” What’s produced and how is it measured? Who are the consumers, what are they “buying” and what do they pay?)
  • Explain how each of the above is likely to respond to incentives – that is, predict their behavior.
  • What did you learn about the incentives facing the Soviet firm that informs your analysis of the public school / private school comparison?

Teacher Note: This assessment requires a transfer. Some students will need more help than others in answering the question, not because of their understanding of the definition of incentives, but because of difficulties transferring their understanding to a new situation. It is important to intentionally teach transfer rather than assuming students will “get it” by themselves. Encourage students to approach this problem by looking at the assessment problem and the scenarios they worked on in groups and asking “What’s the same?” and “What’s different?” Emphasize the worksheet questions that ask students to transfer – the effects of changing targets from number units to weight, for example – by pointing out this transfer to students and asking them to define the steps they took in making the transfer.

Procedures:
  1. Review with students the definition of Incentives:
    • Incentives are rewards or penalties that influence people’s behavior.
    • Prices are incentives for buyers and sellers in market economies.
      • Changing prices change people’s willingness to buy or sell.
    • Remind students that in the Soviet Union prices did not change with market forces and that firms were not allowed to keep any profits they made, so prices and profits did not act as incentives in the same way as they do in our economy.
      • The focus here is to identify the incentives that, in the absence of market prices, operated in production and sale of goods and services in the Soviet Union, and to use recognition of those incentives to explain behavior that would otherwise seem strange and illogical.
  2. Distribute handouts, Perverse Incentives, and work through scenario 1 with the entire class.
  3. Divide students into discussion groups of about 4-6. Appoint a discussion leader, a recorder, and someone whose job it is to help guide the discussion by asking 2 questions when necessary or appropriate:
    • have we identified the incentives?
    • how is this behavior the same as and different from behavior we would expect as a result of the incentives that operate in market based economies?

    Group work time for scenarios 2-5.
    (To shorten the exercise, assign one scenario to each group, making sure that there are 2 groups working on each scenario.)

  4. Debrief
    • Share solutions, conclusions, etc. in large group.
      or
    • Pair the discussion groups. One group presents a scenario and their analysis and the other group evaluates. Groups switch roles for the next scenario.
      or
    • After students have discussed all the problems, assign each group to present one to the assembled class.
Student Handouts:   Perverse Incentives

Scenario 1

Professor Judy Thornton of the University of Washington reports that when she was a student in Moscow, “…the small, blue metal lamp on my dormitory desk was so heavy it took two people to lift it. The lamp base had been filled with lead …”

The problem of grossly heavy products was not limited to the lamp industry, however. Professor Thornton tells of a cartoon that appeared in Krokodil, a popular weekly magazine, in which the entire staff of a plant is shown carrying a single giant nail out of the factory.

Clues

  • Both of the factories mentioned here – the lamp factory and the nail factory – faced quotas and devised strategies to meet and exceed their quotas. Being paid depended on meeting the quotas and bonuses were given for exceeding them.

Given this information:

  1. Predict the basis on which the quota of the lamp factory was set.
  2. Change the quota to another basis and predict the resultant change in behavior and in output.
  3. Finish the caption on the nail cartoon: “Well, comrade, I see that our quota is measured in _________ this month.”
  4. Predict the change in the cartoon picture change if the caption read, “Well comrade, I see that our quota is measured in finished units this month.”
  5. Professor Thornton also experienced the effects of changing the output targets or basis on which the quotas were calculated. When her desk lamp burned out, she found that the state stores had “…tiny night lights or giant flood lights but not bulbs suitable for a desk lamp.” She discovered that the explanation for the production of light bulbs no one wanted and the failure to produce light bulbs people needed was found in the output targets. The output target that resulted in thousands of tiny night lights was _________________. When the output target was changed to ______________, the result was giant flood lights.
  6. Professor Thornton explains that the quota based incentives encouraged factories to consciously sacrifice or trade off “the unmeasured dimensions of product quality in order to maximize on measured dimensions.”
    • What do you suppose that means?
    • Suppose the measured dimension of a clothing factory’s’ output was number of finished units.
      • List some of the “unmeasured dimensions” of clothing that the factory could alter in order to maximize the number of finished products each month.
    • If the output target is number of finished units, predict the size of clothing that would be most available in the state stores.
    • What target would change the clothing size to the other end of the spectrum?

Scenario 2

In their book, Meltdown – Inside the Soviet Economy, authors Paul Craig Roberts and Karen LaFollette report on the seemingly mysterious propensity of Soviet geologists for drilling many shallow holes rather than a smaller number of deep holes. Since most of the oil deposits lie at relatively deep levels, it is not too surprising that “…Soviet geological expeditions in the Republic of Kazakhstan have not discovered a valuable oil deposit for many years…. The surprising fact is that they were “…considered successful …. The geologists and ministers are paid handsomely for their efforts, everyone goes out and gets drunk, and no one cares that the whole exercise has been an extraordinary waste of time and money.” (p.10)

Further investigation reveals that Soviet geologists are very well-educated and clearly no less intelligent than geologists in the rest of the world. How then, can we explain their actions?

Clues

  • In the process of oil-well drilling, the deeper the hole, the slower the drilling progress.
  • The Soviet geologists were paid on a quota and premium system; that is, they were paid if they reached their quota and received bonuses if they exceeded it.

Given this information:

  1. Start with the quota system. What do you suppose the quotas were based upon?
    • Brainstorm a list of possibilities.
  2. For each item on your brainstorm list, identify the incentives for the geologists and predict the behavior they would be most likely to engage in. Which item on your list best explains the behavior the authors reported?
  3. If you were the minister in charge of oil production, how would you change the system to create incentives that would encourage the production of oil rather than oil wells?
    • What perverse outcomes might occur as a result of your new target?

Scenario 3

Roberts and LaFollette report on another phenomenon of the Soviet system – the virtual impossibility of obtaining spare parts:

“The perpetual shortage of spare parts and the dismal repair service in every Soviet industry can also be traced to the bizarre [production] incentives …. Indeed, factories suffer such a severe shortage of spare parts that workers often ‘undress’ finished goods to acquire the needed parts before delivery. Repairs are a nightmare. In a typical instance, a state farm in Minsk sent its trucks to be repaired by the Slutsky Auto Repair Shop. The repair shop insisted on full payment before the farmers could inspect the trucks. Little wonder that they wanted their money first, because even poorly fixed trucks would have been an improvement over the truth: not only had the trucks not been fixed at all, but they had been stripped bare of parts they started out with. The farm’s driver had to haul them back to the farm where two weeks were spent replacing the parts and fixing the stripped trucks. Too late, the farmers learned that sizeable (sic) bribes must be paid to repair people to ensure the intended outcome. Members of the repair shop staff have turned their employer into their own private gold mine.

The Soviet press cites numerous instances of simple repairs that cannot be done because of an acute shortage of a tiny part. One woman was told she could not have her sewing machine fixed because a fastening screw was missing from the machine, a part that for years has been almost impossible to find. The unavailability of parts afflicts items as diverse as washing machines, refrigerators, irons, hair dryers, mixers, calculators, saws, and drills, reducing them to junk without the needed replacement parts.” (p. 13-14)

The question for you to consider is: Why doesn’t anyone produce spare parts?

Clues:

  • Factories have the ability to produce spare parts. For example, a tractor factory could spend part of its time and other resources to produce spare parts for its finished products.
  • Again, the answer is not stupidity – or even ignorance or lack of information. The shortage of spare parts is a problem everyone knows, and complains, about. In fact, as Roberts and LaFollette report,
    • “A shadowy character has arisen from the universal shortages: the tolkach. …The tolkachi are people who have a network of personal connections enabling them to locate a source for virtually any item. They extensively use the black market in stolen state goods and are provided with expense accounts to wine and dine and bribe anyone who can wrangle supplies.” (p. 15)
  • Don’t get sidetracked by character issues. No one has found any evidence to support the idea that Soviet citizens were markedly different in their essential human character from people living in other places – no more or less naturally likely to steal, bribe, cheat etc.

Given this information:

  1. Start with incentives. Given what you have learned about the Soviet system, how do you suppose that managers of tractor factories are paid?
    • Predict – what are the “…bizarre incentives…” that Roberts and LaFollette refer to?
  2. Why do you suppose there were no factories specifically for the production of spare parts? (Now you have to think about the incentives facing not only the factory managers but also the planning ministers.)
  3. Predict the impacts of the shortage of spare parts on the system as a whole. How did the system adapt? (For example, just because the tractor is broken doesn’t mean that farm work stops. What kinds of accommodations are likely to take place? What is the net effect on the production?)
  4. How might you change the incentives to produce more desirable outcomes? (What is the desirable outcome?)

Scenario 4

It was common in the Soviet Union for very showy dedication ceremonies to mark the opening of new buildings, housing, and other major constructions. Consider the following description of what went on behind the scenes as the official acceptance committee came to celebrate the completion of a new apartment building in which some of the bathtubs had been stolen.

“‘…the construction superintendent …was triumphantly showing the official acceptance committee around the first stair landing … and he did not omit to take them into every bathroom, too, and show them each tub. And then he took the committee to the second-floor landing, and the third, not hurrying there either, and kept going into all the bathrooms – and meanwhile the adroit and experienced [laborers], under the leadership of an experienced foreman plumber, broke bathtubs out of the apartments on the first landing, hauled them upstairs on tiptoe to the fourth floor and hurriedly installed and puttied them in before the committee’s arrival.'” (11-12)

Clues:

  • People cannot occupy an apartment building until it has been officially accepted.
  • The construction company is allotted a number of bathtubs for each project.

Given this information:

  1. Explain the moving bathtub scam in terms of incentives (at all levels).
    • Why were the building officials willing to go along with the scam?
    • Why were the workers?
  2. Predict the reactions of potential apartment dwellers.
    • Will they be unwilling to move into an apartment because it doesn’t have a bathtub?
    • Predict the likelihood that someone who moves into a bathtub-less apartment will be able to get the construction company to install one.
    • What might be more effective ways for the apartment dweller to secure a bathtub?
  3. Generalize from this instance and your insight into the incentives facing workers and managers in the construction industry – what would you predict to be the general level of construction quality in the Soviet Union and why?
  4. Who bore the costs of the perverse incentives that permeated the construction industry?

Scenario 5

The following anecdote circulated in the United States in the late 1980s and seems to have come from the experiences of Americans traveling in the Soviet Union.

In the streets and informal markets of the city, there were vendors of light bulbs and they often had significant numbers of buyers. At first glance, this wasn’t surprising, as any visitor who had entered a Soviet building could easily see that light bulbs were apparently in short supply. Entryways and stairwells were often quite dark, and when light fixtures were in evidence, they almost never had bulbs. So, it didn’t seem strange to see people buying light bulbs – until, that is, the observer discovered that the people were buying light bulbs that didn’t work. The bulbs often looked normal enough, but usually the filament was broken and the bulb had burned out. Even more amazing is that the customers seemed to know and accept that the bulbs wouldn’t work. When asked why he was purchasing broken light bulbs, one Soviet citizen seemed puzzled that the American observer would ask, and responded, “Well, to take them to work, of course.”

Clues

  • Light bulbs were in perennially short supply in the Soviet Union.
  • Government offices, factories, etc. received shipments of light bulbs first. Only then were remaining bulbs offered for sale in state stores.
  • Despite this fact, hallways, closets, and bathrooms in government offices and factories were almost always dark.
  • There did not seem to be any serious government effort to stop the sale of broken bulbs.

Given this information:

  1. Explain the phenomenon of the burned-out-light-bulb vendors in terms of incentives and their effect on human behavior. Include the behavior of:
    • light-bulb vendors,
    • workers / consumers,
    • government officials.
  2. Compare and contrast the ways in which American citizens and Soviet citizens “pay” for light bulbs.
  3. Soviet citizens paid for light bulbs with money, but they also paid in other ways. What non-monetary “payments” did they make?
    • Do you think the non-monetary costs or the money cost was a greater burden? Explain your thinking.

Teacher Notes – Scenario 1

  1. The output targets for the lamp factory were set in terms of tons of finished output.
  2. Suppose the quota was set in number of finished units. One would expect the lamps to be very small and extremely lightweight. The new problem would not be moving them, but keeping them from being broken.
  3. tons
  4. Millions of tiny, skinny nails, not long enough to go through a board or hold anything together.
  5. number of units (tiny light bulbs maximize this) to total wattage (huge flood lights)
  6. The short answer here is that the Soviets got what they asked for. If they measured number, but not size, they got a large number of units and size was adjusted. If they measured weight, weight was increased and number of units was adjusted. Because quality was not measured – that is, included in output targets – quality was usually sacrificed to meet the measured standards.
    • Measuring clothing output in finished units meant getting lots of small clothes – an overabundance of baby clothes and no coats for adults.
    • If clothing output was measured in yardage of cloth, then large men would have coats and children would have none.

Teacher Notes – Scenario 2

  1. The output targets were based on meters drilled. Since drilling slowed down as the hole became deeper, it was much faster to drill lots of shallow holes than one or two deep holes. When oil lies far below the surface, the likelihood of finding much oil is small.
  2. Remind students that they cannot just change to market pricing; they must come up with an output target. Many groups will immediately change the output target to barrels of oil; encourage them to think how they would behave. Some possibilities: Firms would be reluctant to drill unless they were certain of hitting oil, so less drilling would occur. When oil was found, numerous wells would be drilled in a small area to maximize the number of barrels that could be extracted in a short time. One effect might be a very erratic supply of oil – large amounts until a drilling area was depleted, then very little – because no one wanted to take the risks of drilling a dry well.

Teacher Notes – Scenario 3

  1. Roberts and LaFollette offer the following evidence of the perverse incentives that result from quotas based on new production: “One planning engineer in a machinery manufacturing plan explains the lack of spare parts: ‘The director of this factory figures that if he puts out 100 machines with the proper quantity of spare parts, he does not get a premium. But if he puts out 102 machines and no spare parts, then the chief engineer and all the technical personnel get premiums. There is not enough stimulus for producing spare parts.'” (p. 13)
  2. No one celebrated partial production. The ministers wanted to be able to tell the planners about finished production – numbers of new tractors. The planners would trumpet their phenomenal successes in the headlines of Pravda, the official newspaper. No one wanted to talk about old tractors breaking down and needing repair. The ministers’ positions and influence rested on their ability to tell the planners that goals for new output were being met. Producing spare parts took resources away from new output.
  3. The overall impact of the shortage of spare parts was to slow down production and innovation. Valuable resources – especially human time and ingenuity, went into “making do,” crafting a replacement part out of whatever was handy, in order to keep machinery running. The result was that even though the machinery was running, it was likely to be less productive. Managers of factories and farms were reluctant to accept new or unproven technologies and innovations because they didn’t know how reliable they would be, and at least with the old machinery, they had figured out a way to keep it running. As you can see, the outward ripple of inefficiency would spread; the net effect of the lack of spare parts was lower productivity, lower output, and lower standards of living.
  4. Students may generate a variety of answers here. Whatever their answer, ask them to identify incentives and how those incentives are likely to impact production. Ask them to think beyond short term and to look for unintended consequences.

Teacher Notes – Scenario 4

  1. The official acceptance committee, the construction superintendent, and the workers were rewarded in terms of finished construction, and the apartment could not be called finished until the inspectors had seen the bathtubs. Conversely, there was no penalty to the officials, the superintendent or the workers, once the building was declared “finished,” for an apartment that had no bathtub. In fact, consumer complaints were often met by blaming the consumer:
    • One hapless woman bought a down comforter. In the winter when she tried to use it, the down and feathers came out through the covering. She sent the comforter back to the Kotovsk Down and Feather Factory to be replaced. …the factory wrote a nasty letter accusing her of abusing the comforter and causing the stuffing to come out. Pravda correspondent A. Golovenko says that this kind of response is very common; a factory director can “beat off any ‘nonscientific’ complaint sent by a simple-hearted buyer as if it were a piece of fluff. All he has to do is accuse the buyer of not following the instructions for using the item.
  2. Apartment dwellers would wait in line to move into an apartment with no bathtub – because the alternative was no apartment. Waiting lists for apartments were 5-20 years.
    • The apartment dweller will have no luck getting a bathtub from the construction superintendent; remember that he is rewarded for new construction, not for making repairs to apartments that have already been officially accepted as finished.
    • The best way for an apartment dweller to secure a bathtub would be to buy one on the black market (maybe from the person who took them from the unfinished apartment building in the first place!)
  3. Construction quality was abysmal, running the gamut from ugly to dangerous. The stereotype of the crumbling concrete box structure is firmly grounded in reality.
    • Given that output targets are in terms of finished units, the measured dimension becomes the number produced; the unmeasured dimension that is routinely sacrificed is quality.
  4. Apartment dwellers bore the costs.

Teacher Notes – Scenario 5

  1. Workers take the burned-out light bulbs to work, hidden in their pockets. When they go to the bathroom, or find themselves alone in a hallway or supply closet, they replace the working bulbs there with the burned out bulbs from their pockets. They take the new bulbs home. The factory reports another burned out bulb and receives more when they become available.
    • Light bulb vendors are motivated by profit to accept the risks of a quasi-legal enterprise.
    • Workers accept the costs and risks of petty thievery from their employers because the transaction costs of getting light bulb legally are so high.
    • The government looks the other way because the costs of acknowledging and dealing with the problem of shortages are so high.
  2. American citizens pay for light bulbs by trading their income (earned by working) for bulbs. Soviet citizens pay for light bulbs with their time as well as with their money.
  3. The non-monetary costs to the Soviet citizens include such things as time spent finding light bulbs and time spent waiting in line. (Economists refer to these as transaction costs. Transaction costs are the focus of activity #5.)