Neuroeconomics: How Neuroscience Can Inform Economics

Abstract

Neuroeconomics uses knowledge about brain mechanisms to inform economic analysis, and roots economics in biology. It opens up the “black box” of the brain, much as organizational economics adds detail to the theory of the firm. Neuroscientists use many tools— including brain imaging, behavior of patients with localized brain lesions, animal behavior, and recording single neuron activity. The key insight for economics is that the brain is composed of multiple systems which interact. Controlled systems (“executive function”) interrupt automatic ones. Emotions and cognition both guide decisions. Just as prices and allocations emerge from the interaction of two processes—supply and demand— individual decisions can be modeled as the result of two (or more) processes interacting. Indeed, “dual-process” models of this sort are better rooted in neuroscientific fact, and more empirically accurate, than single-process models (such as utility-maximization). We discuss how brain evidence complicates standard assumptions about basic preference, to include homeostasis and other kinds of state-dependence. We also discuss applications to intertemporal choice, risk and decision making, and game theory. Intertemporal choice appears to be domain-specific and heavily influenced by emotion. The simplified ß-d of quasi-hyperbolic discounting is supported by activation in distinct regions of limbic and cortical systems. In risky decision, imaging data tentatively support the idea that gains and losses are coded separately, and that ambiguity is distinct from risk, because it activates fear and discomfort regions. (Ironically, lesion patients who do not receive fear signals in prefrontal cortex are “rationally” neutral toward ambiguity.) Game theory studies show the effect of brain regions implicated in “theory of mind”, correlates of strategic skill, and effects of hormones and other biological variables. Finally, economics can contribute to neuroscience because simple rational-choice models are useful for understanding highly-evolved behavior like motor actions that earn rewards, and Bayesian integration of sensorimotor information. Who knows what I want to do? Who knows what anyone wants to do? How can you be sure about something like that? Isn't it all a question of brain chemistry, signals going back and forth, electrical energy in the cortex? How do you know whether something is really what you want to do or just some kind of nerve impulse in the brain. Some minor little activity takes place somewhere in this unimportant place in one of the brain hemispheres and suddenly I want to go to Montana or I don't want to go to Montana. (White Noise, Don DeLillo)

How Time Preferences Differ: Evidence from 45 Countries

“…Such time inconsistency has also been found in non-human animals (Du et al, 2002;Fehr, 2002;Green, Fisher, Perlow, & Sherman, 1981;Mazur, 1987;Rodriguez & Logue, 1988). Studies from psychological, ecological and neurological perspectives help us to understand the deeper roots of this behavioral pattern (Green & Myerson, 1996;Camerer, Loewenstein, & Prelec, 2005).…”

Impulsive consumption and reflexive thought: Nudging ethical consumer behavior

“…In order to provide such an explanation, more insights are needed to understand what mechanisms correspond to β and δ, or System 1 and System 2, respectively. That is to say, to understand impulsivity more thoroughly the factors that strengthen or weaken each of the two systems need to be elaborated upon (Camerer et al, 2005;Hoch and Loewenstein, 1991).…”

The effects of time delay in reciprocity games

“…Dual-processing accounts of human behavior (see Evans, 2008 for a review) suggest that choice is determined by two distinct processing systems, which can account for economic behavior (Camerer, Loewenstein, & Prelec, 2005). "System 1" involves automatic and intuitive processes that proceed relatively rapidly, whereas "System 2" involves controlled and reflective processes that proceed relatively slowly Stanovich & West, 2000).…”