One example each for three principles of economics: incentives, government and the margin

(i) People respond to incentives. An incentive is the prospect of a reward or a penalty, and it moves people to act in a particular way. Because behaviour changes when rewards and penalties change, anyone framing a policy must think through how people will react; otherwise the policy can have results nobody intended. Governments use this deliberately: they tax what they want less of and subsidise what they want more of.

Example: parking charges in a crowded market. Our own example. A city corporation raises the parking fee at a crowded wholesale market from ₹20 to ₹100 for two hours.

• The intended response. Many shoppers now find driving too costly; some take the metro or an auto-rickshaw, some share a cab, and traders shift deliveries to early morning. Fewer cars enter, and congestion eases.
• A response nobody planned for. Some drivers avoid the fee by parking in the residential lanes around the market, which now become jammed. The corporation has to extend the charge or the no-parking rule to those lanes as well. The same price signal changed what people did, in the way the policy wanted and in a way it did not: both are responses to the incentive.

(ii) Governments can at times improve outcomes in the market. Markets usually organise economic activity well, but the government still has a role. Markets need rules to be enforced and order to be kept, so that sellers can be sure of being paid; and the government is needed to pursue both efficiency and equality. The words at times matter, though: the government is not always able to bring about the improvement it wants. One clear case is a public good, which no one can be kept from using and whose use by one person does not reduce what is left for others. Left to the market, such a good is supplied in too small a quantity, or not at all.

Example: street lights for a new colony. Our own figures. A new colony of 400 houses has dark streets. Each household values lighting at ₹500 a year, so the colony as a whole gains ₹2,00,000 a year; lighting every street costs ₹1,50,000 a year.

• Why the market fails here. Once the lights are on, they light the street for every household, whether or not it paid. Each household hopes the others will pay, so voluntary contributions fall short and the lights are never put up, although the benefit exceeds the cost. A person who enjoys a good without paying for it is a free rider.
• How the government improves the outcome. The municipality compares the total benefit with the total cost, as a cost-benefit test requires; since ₹2,00,000 exceeds ₹1,50,000, it installs the lights and recovers the cost through property tax, which every household must pay. Compulsory payment removes the free rider problem, and the colony gains ₹50,000 a year more than the lights cost.
• The limit. Had the lights cost ₹2,50,000 a year, the same test would have said no: government action improves the outcome only where the benefit exceeds the cost.

(iii) Rational people think at the margin. Few decisions are all or nothing; most are about a little more or a little less of something. The margin is this edge, the small incremental change, and a rational decision maker compares the extra benefit of a step with its extra cost, rather than looking at averages. Costs that will be paid whatever is decided, such as fixed costs, do not enter the comparison.

Example: an export order below average cost. Our own figures. A garment factory in Ludhiana produces 10,000 shirts a month at an average cost of ₹500 a shirt, of which ₹150 is rent, machinery and salaried staff that do not change with output. It has spare machine time. A foreign buyer offers to take an extra 1,000 shirts at ₹420 each.

• Thinking in averages: ₹420 is below the average cost of ₹500, so the order looks like a loss of ₹80 a shirt.
• Thinking at the margin: the extra cost of each additional shirt is only cloth, thread, power and overtime, ₹350 a shirt, because the fixed ₹150 is paid anyway. The marginal benefit (₹420) exceeds the marginal cost (₹350), so the order adds 1,000 × ₹70 = ₹70,000 to monthly profit. The rational owner accepts the order. He would refuse it only if the price fell below ₹350, the extra cost of one more shirt.

Conclusion. Each principle explains a familiar decision: a higher parking fee changes how people travel because they respond to incentives; a municipality can provide street lights that the market would not, because public goods invite free riders; and a factory gains by accepting an order below its average cost, because what matters is the comparison of marginal benefit with marginal cost.