[Paleopsych] Economist: Economics focus: Mind games

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Economics focus: Mind games
http://www.economist.com/finance/PrinterFriendly.cfm?Story_ID=3556121
5.1.13

    Can studying the human brain revolutionise economics?

    ALTHOUGH Plato compared the human soul to a chariot pulled by the two
    horses of reason and emotion, modern economics has mostly been a
    one-horse show. It has been obsessed with reason. In decisions from
    how much to produce to whether to save and invest, humans have been
    assumed to be coolly rational calculators of their own self-interest.
    Over the past few years, however, evidence from psychology has
    persuaded many economists that reason does not always have its way.
    Now, judging from a series of presentations at the American Economic
    Association meetings in Philadelphia last weekend, a burgeoning new
    field dubbed "neuroeconomics" seems poised to provide fresh insights
    on how the two horses together produce economic behaviour.

    The current bout of research is made possible by the arrival of new
    technologies such as functional magnetic-resonance imaging, which
    allows second-by-second observation of brain activity. At several
    American universities, economists and their collaborators in the
    neurosciences have been placing human subjects in such brain scanners
    and asking them to perform a variety of economic tasks and games.

    For example, the idea that humans compute the "expected value" of
    future events is central to many economic models. Whether people will
    invest in shares or buy insurance depends on how they estimate the
    odds of future events weighted by the gains and losses in each case.
    Your pension, for example, might have a very low expected value if
    there is a large probability that bonds and shares will plunge just
    before you retire.

    Brian Knutson, of Stanford University, carried out one recent
    brain-scan experiment to understand how humans compute such things.
    Subjects were asked to perform a task, in this case pressing a button
    during a short interval in which a certain shape was flashed on to a
    screen. In some trials, the subjects could win up to $5 if successful,
    while in others they would have to defend against a $5 loss. Before
    presenting the target, the researchers signalled to subjects which
    kind of trial they were in.

    Brain activity in certain neural systems seemed to reveal a strong
    correlation with the amount of money at stake. Moreover, the prospects
    of gains and losses activated different parts of the brain.
    Traditional economists had long thought--or assumed--that the prospect
    of a $1,000 gain could compensate you for an equally likely loss of
    the same size. In subsequent trials, subjects were given another
    signal: one that provided an estimate of the odds of success. That
    allowed the researchers to identify the regions of the brain used for
    recognising an amount of money and for estimating the probability of
    winning (or losing) it. Having identified these regions, the hope is
    that future work can measure how the brain performs in situations such
    as share selection, gambling or deciding to participate in a pension
    scheme.

    David Laibson, an economist at Harvard University, thinks that such
    experiments underscore the big role that expectations play in a
    person's well-being. Economists have usually assumed that people's
    well-being, or "utility", depends on their level of consumption, but
    it might be that changes in consumption, especially unexpected
    downward ones, as in these experiments, can be especially unpleasant.

    Mr Laibson's own work tries to solve a different riddle: why people
    seem to apply vastly different discount rates to immediate and
    short-term rewards compared with rewards occurring well into the
    future. People tend much to prefer, say, $100 now to $115 next week,
    but they are indifferent between $100 a year from now and $115 in a
    year and a week. In one recent experiment, noted in our science
    section on October 30th, Mr Laibson and others found that the brain's
    response to short-term riches (in this case, gift certificates of $15
    or $20) occurs largely in the limbic system, a region that governs
    emotion. By contrast, the prospect of rewards farther into the future
    triggers the prefrontal cortex, which is often associated with reason
    and calculation. Thus, choosing immediate economic gratification, by
    spending excessively on credit cards or not saving enough even though
    you "know better", could be a sign that the limbic system is in
    charge. Government policies, such as forced savings or "cooling off"
    periods for buying property or cars, may be one remedy.

    And then there is trust and deception. Colin Camerer, of the
    California Institute of Technology, has conducted experiments in which
    brain-scanned participants play strategic games with anonymous
    partners. In these, a subject chooses his own actions and also tries
    to anticipate the choices of the other player. When players are doing
    the best that they can to "win" the game by anticipating their
    opponents' moves, their brains tend to show a high degree of
    co-ordination between the "thinking" and the "feeling" regions.
    Economic equilibrium, by this measure, is an identifiable "state of
    mind".

    Don't let it go to your head

    Some neuroeconomists claim that such brain-scanning experiments are
    the start of a revolution in economics. No longer will economists rely
    on crude statistical models of how people behave in response to a
    policy change, such as an interest-rate rise or a tax increase.
    Instead, they will be able to peer directly into the brain to predict
    behaviour.

    One day, perhaps; but much work remains. Identifying the parts of the
    brain that control economic actions is one thing. Harder tasks include
    determining how neural systems work together to create behaviour, and
    how wide is the variation in brain patterns between different people.
    Then there are age-old questions of free will: is your failure to save
    for old age simply a lifestyle choice, or is it down to faulty brain
    circuits? Neuroeconomics is already providing fascinating conclusions.
    But Plato's chariot will remain an alluring explanation for a while
    yet.