Man is equipped with the psychical and physical make-up of his first human ancestors; he is the sort of being who functions best in the exhilarations and the fatigues of the hunt, of primitive warfare, and in the precarious life of nomadism. He rose superbly to the crises of these existences. Strangely and suddenly he now finds himself transported into a different milieu, keeping, however, as he must, the equipment for the old life. Fortunately his power of reflecting (there seems to be an innate tendency to reflect and learn which is a distinguishing characteristic of our species) has enabled him to persist under the new conditions by modifying his responses to stimuli.Rexford G. Tugwell,
Journal of Political Economy, 1922
Rexford Tugwell’s brilliant analysis of human behavior represents one of the last gasps of a sophisticated psychological account of economic behavior that was once integral to economics (cf. Ashraf et al. 2005), but was lost to the field for almost a century. Neuroeconomics is an interdisciplinary field that explains the human decision making behavior, the ability to process various alternatives and follow a course of action. It studies how economic behavior can shape our understanding of the brain and how neuroscientific advancements can guide models of economics. It tries to bridge the disciplines of neuroscience, psychology and economics.
Neuroeconomics has inspired more change within economics than within psychology because the most important findings in neuroeconomics have posed more of challenge to a standard economic perspective. Professor Michael Platt from the Wharton University of Pennsylvania spoke to the World Economic Forum in Davos to explain how the discipline could help us to make better decisions. He asserts, “We can measure how much you value something by looking inside your brain. You don’t even have to tell us anything about it. So we can measure your preferences by putting you on an MRI machine and taking snapshots of your brain in action and we can predict your decisions. The brain weighs evidence and value separately to make a decision.’’
Breaking Down ‘Neuroeconomics’
Insight into the mechanism driving individuals to make a certain decision can help to better predict the future of economics. The need to fill certain gaps in conventional economic theories is fundamental to the study of neuroeconomics. Economic decision-making, in the traditional sense, suggests that investors or customer will objectively evaluate the risk or need and react in the most rational manner. In some cases, human behavior does not follow economic theory or optimize utility.
For example, history has shown the perpetuation of asset bubbles and, subsequently, financial crises. Neuroeconomics provides insight into why humans do not act to optimize utility and avoid financial difficulty. Typically, emotions profoundly influence individuals’ decision-making. The brain often reacts more to losses than to gains, which can stimulate irrational behavior. While emotional responses are not always suboptimal, they are rarely consistent with the concept of rationality. As neuroeconomics becomes more developed, the field of study will improve the understanding of the mechanisms influencing decision-making.
There are four major areas of study of neuroeconomics:-
- Decision-making under risk and uncertainty explains the difficult position of an individual who is incorporating risk into his strategy in order to gain maximum outcome. For example, managers who integrate risk into their strategy decisions, which requires information on the probability distribution of outcomes such as expected value of returns, the variance and standard deviation.
- Game theory – It applies mathematical models of conflict and cooperation between rational and intelligent decision makers. Game theory perfectly explains oligopolistic nature of oil, which totally depends upon choices made by the players in the industry.
- Intertemporal choice is the process by which people decide what and how much to do at various times; choices made at one time influence the choice available at other times.
- Social decision making – While most research on decision making tends to focus on individuals making choices outside of a social context, it is also important to consider decisions that involve social interactions. An important aspect of social interaction is trust. The likelihood of one individual cooperating with another is directly related to how much the first person trusts the second to cooperate.
Applications of Neuroeconomics
- According to the World Economic Forum, in 2016, Professor Michael Platt from the Wharton University of Pennsylvania spoke at Davos and explained that researchers at Stanford University found that they could predict the effectiveness of internet microcredit campaigns by scanning the brains of participants in a laboratory setting. Platt also suggested marketers could use the approach to influence consumer behavior; for example, to encourage better choices regarding food or health-related activities. In other words, it can be termed as ‘precision marketing’.
- Trust behavior seems to be related to the presence of oxytocin, a hormone involved in maternal behavior and pair bonding in many species. When oxytocin levels were increased in humans, they were more trusting of other individuals than a control group even though their overall levels of risk-taking were unaffected suggesting that oxytocin is specifically implicated in the social aspects of risk taking.