Neuroeconomics: How Neuroscience Can Inform Economics¶
Motivation(s)¶
The foundations of economic theory were constructed assuming that the details of the brain’s black box would not be known. In order to sidestep this limitation, economists combined subjective expected utility with the rational choice theory and the revealed preference theory from psychology; the latter theory simply equated unobserved preferences with observed choices. This resulted in the establishment of behavioral economics whose theories are reasonable as long as the brain remained a black box, but the brain is slowly being demystified as recent advances in neuroscience start to enable direct measurement of thoughts and feelings.
Proposed Solution(s)¶
The authors assert neuroscience can make incremental and radical contributions to economics. The former enhances existing models of decision making (e.g. dynamic cross-partial effects in utility for commodity bundles, environmental cues trigger unpleasant cravings and increase demand) while the latter forms a different foundation for economic theory. This foundation has been branded as neuroeconomics and focuses on the interaction between controlled and automatic processes, and between cognitive and affective systems unlike the existing theory that represents decisions in a deliberative equilibrium.
Evaluation(s)¶
The authors’ goal is to showcase some key findings and neuroscience and stimulate the reader’s curiosity about the implications for economics. The latest advancements (e.g. EEG, PET, fMRI, TMS, EBS, DTI, electrophysiology, psychophysical) indicate neural functioning can be described in terms of cognitive, affective, controlled, and automatic processes. The survey of experimental findings provide possible alternative explanations that are more sound than economic models with arbitrary assumptions.
Future Direction(s)¶
How to apply Bayesian models and likelihoods to simulate specialized functions such as the mentalizing module?
Monitor the brain activity of day traders at different experience levels.
Question(s)¶
How consistent are the proposed methods of evaluation?
Analysis¶
Neuroscience provides a way to replace the arbitrary assumptions in economic models with consistent parameters reflective of neurological functions. Since the suggestive evidence are still being studied further, the authors should have tried to incorporate these findings into economic models and evaluate the impact.
One of the interesting points was that companies have already made use of the fact consumers have a preference for prepayment (even though it is financially irrational), and they will go to great lengths to avoid having consumers think about marginal cost.
Some of the experiments, such as measuring cognitive load, are quite questionable. How can memorizing digits of differing lengths and choosing to eat a cake or fruit salad have any implications on self-control? Furthermore, the authors raised the question of whether Bayesian modeling is appropriate to describe specialized neurological functions. Wouldn’t a completely precise process be even more unlikely?
Notes¶
Economic Constructs¶
Economists assume the following characteristics are stable within an individual and consistent across activities: time preference, risk preference, and altruism.
Empirical evidence shows these dimensions are very weakly correlated or uncorrelated across situations since preferences are state-contingent and that people may not recognize state-contingency.
Domain-Specific Expertise¶
Economics implicitly assumes people have general cognitive capabilities that can be applied to any type of problem and will perform equivalently on problems that have similar structures.
The existence of systems that evolved to perform specific functions (e.g. the mentalizing module) suggests that performance will depend critically on whether a problem that one confronts can be processed by a specialized system that is well adapted to that form of processing.
Utility for Money¶
The canonical economic model assumes that the utility for money is indirect i.e. that money is a mere counter, only valued for the goods and services it can procure.
Neural evidence suggests that the same dopaminergic reward circuitry of the brain in the midbrain (mesolimbic system) is activated for a wide variety of different reinforcers e.g. attractive faces, funny cartoons, cultural objects, drugs, money.
Asset pricing models that incorporated stock returns exhibited increased descriptive power in explaining returns patterns.
Wanting and Liking¶
Economists view behavior as a search for pleasure and people will be better off when they get what they want.
Neuroscience argues that decision making involves the interaction between the liking system (e.g. pleasure pain) and the wanting system (e.g. motivation).
When these systems diverge, the welfare economists’ assumptions are invalid.
Cognitive Inaccessibility¶
People lack introspective access to the source of their own judgements of behavior leads to discriminatory biases, self-deception, self-manipulation, and failure to understand the reasons behind their choices.
Intertemporal Choice and Self-Control¶
Economists view intertemporal choice as a trade-off of utility at different points in time.
Individual differences in the way that people make this tradeoff are captured by the arbitrary notion of a discount rate, a rate at which people discount future utilities as a function of when they occur.
Empirical neuroscience research suggested intertemporal choice can be viewed as a splice of two processes: an impulsive, affective, cognitive process and a more far-sighted deliberate process guided by the prefrontal cortex.
Greater relative activity in affective systems was associated with choosing earlier rewards more often.
Individual automatic processes involving pattern matching, recognition, and categorization also influences choice e.g. a preference for sequences of outcomes that improve over time, a preference for flat sequences, a preference for immediate rewards.
Decision-Making under Risk and Uncertainty¶
People’s deliberative selves are not at peace with their visceral reactions to risks e.g. fear unleashes preprogrammed sequences of behavior that aren’t always beneficial.
Insufficient fear can produce nonmaximizing behavior when risker options have negative value.
When guessing probabilities, the left hemisphere of the brain is more active; but when answering logic questions, the right hemisphere is more active.
Game Theory¶
The classic theory assumes the players:
have accurate beliefs about what others will do i.e. players are in equilibrium;
have no emotions or concern about how much others earn;
plan ahead;
and learn from experience.
fMRI studies seem to suggest that game theory may need some modifications.
The insula is a neural locus activated by the distaste for inequality or unfair treatment posited by models of social utility.
The oxytocin hormone level, which rises during social bonding, affects how one perceives the trustyworthyness of others.
Circadian rhythms affect people’s ability to suppress or avoid acting on unwanted feelings.
A good reputation (perception) may be neurally encoded in a way similar to rewarding stimuli.
Backward induction means figuring out what to do today by and reasoning how others will behave at all possible future points and working backward.
Economists are inclided to characterize this as cognitively costly.
Studies have shown that this can be learned and automated.
Camerer-Ho reinforcement two process theory and Glimcher’s parietal neuron measurements suggest that neurons are encoding expected reward values.
Labor-Market Discrimination¶
Economists assume labor-market discrimination against minorities is either a distaste for working with minorities, or a belief that minority workers are less productive.
Through the use of implicit association tests (IATs), neuroscience suggests discrimination involves rapid, automatic, associations between social categories, stereotypes, and affect.
References
- CLP05
Colin Camerer, George Loewenstein, and Drazen Prelec. Neuroeconomics: how neuroscience can inform economics. Journal of economic Literature, 43(1):9–64, 2005.