Armin Falk and Bernd Weber
Universität Bonn, SS 08
Neuroeconomics
Part I: Introduction
Overview
1. Introduction
2. Methods
• Neuroanatomy - macro- and microanatomy of the
human brain
Visit the Institute of Ana...
Papers (to be completed)
• The Neural Basis of Economic Decision-Making in the Ultimatum Game Alan G.
Sanfey, James K. Ril...
What is Neuroeconomics?
• General: Neuroeconomics combines methods from
neuroscience and economics to better understand ho...
Neuroeconomists
• About 100-200 neuroscientists and economists
are actively working in this new field.
• It’s roughly an e...
Neuroeconomics & Behavioral Economics
• Behavioral economics developed alternative models of
economic behavior.
– Prospect...
Why is Neuroeconomics so fascinating?
• Brain research has made great progress during the past
decade, largely due to noni...
What is the goal of neuroeconomics?
Analogy to organizational economics
(Camerer EJ 2007)
• Until 1970s theory of the firm...
Opening the black box of the firm
Contract theory
Opening the black box of the human brain
Neuroeconomics
(See Camerer 2007)
Brain evidence provides a deeper
understanding of behavioral economics results
• Are social preference phenomena better mo...
Neural Basis of Responder Behavior in the Ultimatum Game
(A. G. Sanfey, J. K. Rilling, J. A. Aronson, L. E. Nystrom, J. D....
Details of the Experiment
Differences in brain activity between unfair and fair
offers from a human proposer
Bilateral anterior insula and anterior ...
Results
• Regions showing stronger activations if subjects face unfair
human offers relative to fair human offers (the sam...
Insula activation is related to “unpleasantness”
• Higher for offer of unfair person.
• Higher for more unfair offers.
• H...
General procedure
• Observe subjects‘ brains when they are in a
decision situation.
• Find the voxels which are particular...
What does this procedure rely on?
• Brain regions are functionally specialized. At
least, brain functions are not homogene...
• Neuroscience Methods
• Topics in Neuroeconomics
– Preferences
– Decision-making under risk and uncertainty
– Game theory...
Revealed preferences
• Economists: early doubts about the rationality of
choice (see quote)
– But fear that „unstable and ...
A Timeline of Neuroscience (Methods)
Ward (2006)
Phrenology (Gall, Spurtzheim)
Nerve cell described (Purkinje 1837)
Lesion...
Research with human subjects
• Studying humans with lesions
– Associated deficits provide information about the function o...
Lesion studies
• Naturally occurring lesions
– Accident, stroke, brain tumor.
• Allows to determine that a particular func...
Results gained with lesions
• Broca found an area that is critical for speech
production.
• Humans with lesions of the amy...
Phineas Gage
• Explosion pushed iron
up through the top of
the scull.
• He survived.
• He was intellectually
rather unaffe...
Electro-encephalogram (EEG)
• Measures electrical potentials at the
scull, caused by neural activity.
• Very good temporal...
Magnetoencephalograghy (MEG)
• Rather new method, based on measuring the
magnetic field generated by neural activity.
• Ad...
Positron Emission Tomography (PET)
• A radioactive substance is injected into
the blood.
• This substance emits positrons....
fMRI (Functional Magnetic Resonance
Imaging)
• MRI is based on the principle that protons in a magnetic field align
with t...
Temporal resolution of fMRI
• Blood flow has a lagged
response to neural activity.
(Hemodynamic response function
HRF)
• D...
How is fMRI data analyzed (will be discussed
later)
• Behavioral analysis
• Preprocessing
– Motion correction
– Normalizin...
Block design and event related design
• Block design
• A experimental condition A is repeated several
times, then the cond...
Comparison of PET and fMRI
• Advantages of fMRI:
– higher spatial resolution.
– higher temporal resolution.
– less invasiv...
Transcranial Magnetic Stimulation (TMS)
• Allows “virtual lesions”
• Non-invasive procedure: debated
• A strong, magnetic ...
Pharmacological Methods
 Placebo controlled administration of substances inform
about the functioning of neurotransmitter...
Other methods
• Single Neuron Measurement
– Implantation of electrodes into the brain
– While fMRI measures „cumulative“ a...
Overview of neuroscientific methods
Animal research
• Many brain areas in humans and animals
have similar structures.
– It‘s possible to “produce” addicted ra...
Controlled lesions
• Allows to determine causally whether a particular
brain region (or connection between regions) is
ess...
Topics in Neuroeconomics: Preferences
The following is taken from the Camerer et al. paper Neuroeconomics: Why Economics N...
Preferences
• Preferences are state-dependent
– Whether I like having icecreme depends on the season
– Homeostasis (Gleich...
Preferences
• Utility of money
• Economics: People are expected to value money for what it
can purchase -> indirect utilit...
Flat rates
• Many studies show that consumers choose flat rates even
though marginal use schemes would be “optimal”, i.e.,...
Preferences
• Source of income
– Economics: utility of income is independent of its
source
• Neuroeconomic evidence: earne...
What is “better”: welfare or workfare?
A little digression
• Workfare programs introduced in several
countries
• Unlike re...
This study
(Falk, Huffman and Mierendorff 2006)
1. Study the incentive effects of workfare
2. Assess potential political s...
1. Incentive effects
• Real effort task
– Task has no intrinsic value
– Experiment captures essential tradeoff between
eff...
Count the number of zeros: How many of
these would you do for X Euro?
Seite 1
1 0 0 1 0 1 1 1 1 1 0 1 0 0 0 1 0 0 0 0 0 0 ...
Phases of the experiment
• Phase 1: try the task
• Phase 2: choice tables
– Subjects fill in choice tables
• Phase 3: work...
Example choice table
Option 1 Option 2 I choose
Option 1
I choose
Option 2
4 Euro, 0 sheets 1 Euro, 10 sheets o o
4 Euro, ...
Example choice table
Option 1 Option 2 I choose
Option 1
I choose
Option 2
4 Euro, 9 sheets 1 Euro, 10 sheets o o
4 Euro, ...
Work outcomes and payment
• Subjects know how outcomes are determined:
– One row in one table is randomly selected
– Subje...
Results
0
1
2
3
4
5
6
7
8
5 10
number of sheets
reservation wage (€)
welfare workfare
Incentive effects
are significant
5 ...
2. Political Acceptability
• To what extent do people support workfare?
– What are their motives?
• We study this in a set...
Phases of the experiment
• Voting
– Ss are assigned to groups of 3
– Each group consists of two A and one B
– A’s will pot...
Summary of possible outcomes
B outcome A outcome
B earns money
6 Euro, 10
units
6 Euro, 10
units
B chooses not to
work
Wel...
Is Workfare Fair?
Substantial support for workfare
Voting decision (N=73)
Workfare,
84%
Welfare, 16%
All groups implement workfare; among
23...
Why do people support workfare?
Categorized responses to free-form questions.
Self-interest: workfare gives B an incentive...
Conclusions/end of digression
• Workfare has the predicted impact on reservation
wages
• We find substantial support for w...
Preferences
• Addiction
– Models of rational addiction: current utility depends on a stock
of previous consumption, consum...
Decision-making under risk and uncertainty
Risk and ambiguity
• Economics: risk is equated with variation of outcomes: one...
Decision-making under risk and uncertainty
Risky choice
• Involves an interplay of cognitive and affective processes
• Exp...
Decision-making under risk and uncertainty
Gambling
• Economic puzzle: people both demand insurance
and gamble at the same...
Game theory and social preferences
• Assumption among neuroscientists: there is a
specialized „mind-reading“ area in the h...
Concluding remarks
• Neuroscience measurements offer more reliable and
unbiased data in many cases (e.g., compared to cert...
Final comment
• Neuroeconomics is important and will stay if it
produces scientifically valuable knowledge
• This is true ...
Unfair pay and Stress
(Falk, Menrath, Kupio and Siegrist, 2008)
• Does perceived unfair treatment induce stress?
• Importa...
Health and the workplace
• Specific features at the workplace enhance or reduce
employees’ health through psychosocial str...
Design
• Stylized labor relation, one principal one agent
• Details of the experiment are all commonly known
• Agent produ...
Heart rate variability
• Heart rate variability has been chosen as a
physiological marker in our experiment because
of its...
Three measures of unfairness
• Actual share = payoff of agent/total revenue
• Discrepancy = actual share/appropriate share...
Results
Variable Mean Standard Deviation
Revenue produced by agents (Euro) 20.9 8.57
Actual share 0.43 0.14
Appropriate sh...
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TIFF (PackBits) decompressor
are needed to see this picture.
Figure 1: Discrepancy between actual and app...
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TIFF (PackBits) decompressor
are needed to see this picture.
Figure 2(a): Relation between actual share a...
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are needed to see this picture.
Figure 2(b): Relation between discrepancy an...
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TIFF (PackBits) decompressor
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Figure 2(c): Relation between fairness quest...
Dependent variable: Heart rate variability (RMSSD)
Actual share 38.17**
[12.77]
Discrepancy 18.87**
[6.29]
Fairness 4.13**...
Actual share Discrepancy
Fairness 0.70** 0.79**
Mood 0.56** 0.59**
Anger - 0.58** - 0.70**
Supplemental Table 2: Correlati...
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  • T=0 revelation of offer
  • Wilcoxon rank test.
  • In conclusion, in experiment 1 we find that workfare has the predicted impact on reservation wages, inducing individuals to choose regular employment.
    We believe this result is a useful benchmark.
    In our second experiment we find substantial support for workfare, even though we purposefully make the incentive motive weak.
    We find that an additional, strong source of support for workfare appears to be fairness concerns.
    Workfare is fair in the sense that it equalizes outcomes, and punishes free riders.
  • Neuroeconomics: Why Economics Needs Brains (Camerer, Loewenstein ...

    1. 1. Armin Falk and Bernd Weber Universität Bonn, SS 08 Neuroeconomics Part I: Introduction
    2. 2. Overview 1. Introduction 2. Methods • Neuroanatomy - macro- and microanatomy of the human brain Visit the Institute of Anatomy • Neurophysiology - how neurons communicate • Methods of cognitive neuroscience (EEG, fMRI, PET, MEG....) Visit Life&Brain - NeuroCognition Lab 1. Important neuroeconomics papers (see below)
    3. 3. Papers (to be completed) • The Neural Basis of Economic Decision-Making in the Ultimatum Game Alan G. Sanfey, James K. Rilling,Jessica A. Aronson, Leigh E. Nystrom, Jonathan D. Cohen, Science 13 June 2003, vol. 300. no. 5626, pp. 1755 - 1758 • Getting to Know You: Reputation and Trust in a Two-Person Economic Exchange, Brooks King-Casas, Damin Tomlin, Cedric Anen, Colin F. Camerer, Steven R. Quartz, P. Read Montague, Science, 2005, vol. 308, pp. 78-83. • Neuroeconomics: How Neuroscience Can Inform Economics, Colin F. Camerer, George Loewenstein, Drazen Prelec, Journal of Economic Literature, 2005, vol. 43, 9- 64. • Neuroeconomics: Why economics needs brains, Colin F. Camerer, George Loewenstein, Drazen Prelec, Scandinavian Journal of Economics, 2004, vol. 106, no. 3, 555-79. • Oxytocin increases Trust in Humans, Michael Kosfeld, Markus Heinrichs, Paul Zak, Urs Fischbacher and Ernst Fehr, Nature 435, 2 June 2005, 673-676. • The Neural Basis of Altruistic Punishment, Dominique J.-F. de Quervain, Urs Fischbacher, Valerie Treyer, Melanie Schellhammer, Ulrich Schnyder, Alfred Buck, Ernst Fehr, Science 305, 27 August 2004, 1254-1258. • Strategizing in the Brain, Colin F. Camerer, Science, 2003, vol. 300, pp. 1673-75. • Social Comparison Affects Reward-Related Brain Activity in the Human Ventral Striatum, K. Fliessbach, B. Weber, P. Trautner, T. Dohmen, U. Sunde, C. E. Elger, A. Falk, Science, 2007, Vol. 318, Issue 5854, 1305 – 1308. • Unfair pay and Stress, Falk, Menrath, Kupio and Siegrist, Discussion paper.
    4. 4. What is Neuroeconomics? • General: Neuroeconomics combines methods from neuroscience and economics to better understand how the human brain generates decisions in social and economic contexts – Marriage of neuroscience methods with experimental economics methods • Definition (Laibson): Neuroeconomics is the study of the biological microfoundations of economic cognition. – Biological microfoundations are neurochemical mechanisms, like brain systems, neurons, genes, heart rate, skin resistance, and neurotransmitters. – Economic cognition includes mental representations, emotions, expectations, learning, memory, preferences, decision-making, and behavior.
    5. 5. Neuroeconomists • About 100-200 neuroscientists and economists are actively working in this new field. • It’s roughly an even mix. • This is in contrast to behavioral economics, where it’s a one-sided game (mostly economists and very few psychologists).
    6. 6. Neuroeconomics & Behavioral Economics • Behavioral economics developed alternative models of economic behavior. – Prospect theory, hyperbolic discounting, learning models. – Fairness and reciprocity models. • These models are black box models. They aim to predict behavior better but there is no ambition to understand the mind’s internal processes that generate the behavior. • Questions – Are components of behavioral models represented in brain structures? – Can insights into how the brain works improve economic modeling? – Can those insights discriminate between alternative models?
    7. 7. Why is Neuroeconomics so fascinating? • Brain research has made great progress during the past decade, largely due to noninvasive techniques that allow observing the brain while it is active. • Systematic study of the relation between behavior and brain processes in healthy human subjects is possible. • Possible to provide brain evidence for standard economic theory, allows deeper understanding of (behavioral) economics results • Provide genuinely new insight into the neurobiological determinants of human behavior – and this is genuinely interesting and exciting in itself
    8. 8. What is the goal of neuroeconomics? Analogy to organizational economics (Camerer EJ 2007) • Until 1970s theory of the firm was a radically reduced form model of how capital and labor are combined to produce output. This model neglects – principal-agent relations – Gift exchange – Efficiency wages – Hierarchy and authority – Communication networks – Etc • Nevertheless a useful simplification for deriving industry supply curves and doing macroeconomics • but clearly inapproapriate for a host of interesting questions
    9. 9. Opening the black box of the firm Contract theory
    10. 10. Opening the black box of the human brain Neuroeconomics (See Camerer 2007)
    11. 11. Brain evidence provides a deeper understanding of behavioral economics results • Are social preference phenomena better modelled as „preferences“ or as bounded rationality? • One possibility to answer this question is to examine whether the brain‘s reward mechanisms are activated if people make other-regarding choices • Example: ultimatum game
    12. 12. Neural Basis of Responder Behavior in the Ultimatum Game (A. G. Sanfey, J. K. Rilling, J. A. Aronson, L. E. Nystrom, J. D. Cohen, Science12 13 March ’03) • Responder’s brain activations are measured by fMRI in a $10 UG. • A responder faces each of three conditions ten times. – Offers from a (supposed) human partner – Random offers from a computer partner – Money offer (there is no proposer here) • Research Questions: Which brain areas are more activated when subjects face… – fair offers (3-5) relative to unfair offers (1-2). – the offer of a human proposer relative to a random computer offer. • Method (very simplified): – Regression of activity in every voxel (i.e, 3D Pixel) in the brain on the treatment dummy (i.e., unfair offer dummy, human proposer dummy)
    13. 13. Details of the Experiment
    14. 14. Differences in brain activity between unfair and fair offers from a human proposer Bilateral anterior insula and anterior cingulate cortex. dorsolateral prefrontal cortex. Dorsolateral prefrontal cortex. What you see: Image of voxelwise t-statistic (red) is overlaid on top of a structural brain image (gray).
    15. 15. Results • Regions showing stronger activations if subjects face unfair human offers relative to fair human offers (the same regions also show more activation if the unfair human offer is compared to unfair random offers). – Bilateral anterior Insula, anterior cingulate Cortex • Emotion-related region • Insula also has been associated with negative emotions such as disgust and anger. • Dorsolateral prefrontal Cortex (DLPFC) – Cognition-related region – Associated with control of execution of actions – Associated with achievement of goals. • Unfair offers are more likely to be rejected if insula activation is stronger.
    16. 16. Insula activation is related to “unpleasantness” • Higher for offer of unfair person. • Higher for more unfair offers. • Higher for people who reject. (unclear: Is activation the cause of rejection or a byproduct?)
    17. 17. General procedure • Observe subjects‘ brains when they are in a decision situation. • Find the voxels which are particularly active in particular situations. • For example: Unfair vs. fair offers by humans. • Interpret the observed activations by relating the results to studies that observe activations in the same brain regions. (Should be done ex ante.) • Relate the observed brain activation with behavior.
    18. 18. What does this procedure rely on? • Brain regions are functionally specialized. At least, brain functions are not homogeneously distributed across the brain. • Working parts of the brain show some kind of activity. • This activity is measured with fMRI.
    19. 19. • Neuroscience Methods • Topics in Neuroeconomics – Preferences – Decision-making under risk and uncertainty – Game theory and social preferences
    20. 20. Revealed preferences • Economists: early doubts about the rationality of choice (see quote) – But fear that „unstable and unrational complex“ (emotions, instincts, impulses,…) of influences underlying human choice cannot be measured directly • Economic approach: revealed preference theory – Crucial assumption: unobserved utilities are revealed by observable choices • Breakthroughs in neuroscience: feelings and thoughts can be measured directly
    21. 21. A Timeline of Neuroscience (Methods) Ward (2006) Phrenology (Gall, Spurtzheim) Nerve cell described (Purkinje 1837) Lesion patients (Broca 1861), functional localization Electric current in dog cortex causes movement (Fritsch, Hitzig 1870) EEG (Berger, 1929) Action potential (Hodgkin Huxley, 1938), single cell rec. CT (Hounsfield, 1973), MRI (Lauterbur,1973), imaging PET (Reivich et al., 1979), measure blood flow TMS (Barker et al.,1985), noninvasive stimulation fMRI (Ogawa et al., 1990), measure BOLD 1800 1820 1840 1860 1880 1900 1920 1940 1960 1980 2000
    22. 22. Research with human subjects • Studying humans with lesions – Associated deficits provide information about the function of the lesioned brain area. • Observing the brain – indirect measures (psychophysiological measurements as skin conductance, heart rate) – Brain Imaging (EEG, PET, fMRI) – Pupil dilation -> mental effort – Blood pressure, heart rate, skin conductance -> anxiety • Stimulating the brain – Transcranial Magnetic Stimulation TMS • Enables a controlled, spatially and temporally limited, stimulation or inhibition of brain areas. – Psychopharmacological interventions • Manipulation of neurotransmitter systems or hormone systems.
    23. 23. Lesion studies • Naturally occurring lesions – Accident, stroke, brain tumor. • Allows to determine that a particular function is processed independently from other functions. • Allows to determine causally that a particular region is critical for the performance of a particular task. • Problem – It is often difficult to determine the affected brain region
    24. 24. Results gained with lesions • Broca found an area that is critical for speech production. • Humans with lesions of the amygdala lose affective (i.e. emotional) meaning. • Hippocampus removal prevents experiences from being encoded in long-term memory.
    25. 25. Phineas Gage • Explosion pushed iron up through the top of the scull. • He survived. • He was intellectually rather unaffected by the accident. • He was unable to make reasonable decisions.
    26. 26. Electro-encephalogram (EEG) • Measures electrical potentials at the scull, caused by neural activity. • Very good temporal resolution but poor spatial resolution. • Large number of repetitions of the same situation is necessary. • Interior brain activity is not directly recorded • Further limits: –Eye movement creates also electric activity. –In some regions neurons are not aligned and activity can cancel out.  Not well suited for most economic experiments. 128 electrode array
    27. 27. Magnetoencephalograghy (MEG) • Rather new method, based on measuring the magnetic field generated by neural activity. • Advantages in comparison to EEG – Signal unaffected by skull. – Good spatial resolution (2-3 mm). • Disadvantages in comparison to EEG – Cannot detect signals from deeper brain structures. – Expensive.
    28. 28. Positron Emission Tomography (PET) • A radioactive substance is injected into the blood. • This substance emits positrons. • These positrons decay, together with electrons. • PET detects the brain area where this decay occurs, i.e., it detects the areas into which the radiation went. • Variants: Glucose with radioactive fluorine. Water with radioactive oxygen; measures blood volume. • Better spatial but poorer temporal resolution than EEG • Limited to short tasks
    29. 29. fMRI (Functional Magnetic Resonance Imaging) • MRI is based on the principle that protons in a magnetic field align with the field. If the magnetic field is perturbed the direction of the protons is disturbed. When the protons are redirected in the magnetic field electromagnetic radiation is emitted and is detected by the scanner. • fMRI uses the fact that hemoglobin (red blood cells) have different magnetic properties depending on whether there is little or much oxygen in the blood. • Increased neuronal activity in the brain uses up oxygen such that initially the oxygen level in the activated area falls; later on the fall in oxygen is overcompensated for when oxygen-rich blood moves to the activated area. • BOLD-Signal (blood oxygen level dependent signal).
    30. 30. Temporal resolution of fMRI • Blood flow has a lagged response to neural activity. (Hemodynamic response function HRF) • Does still allow relatively good temporal resolution because HRF is known. • Shortest stimuli that have been detected with fMRI: – Blamire et al. (1992): 2 sec – Bandettini (1993): 0.5 sec – Savoy et al (1995): 34 msec
    31. 31. How is fMRI data analyzed (will be discussed later) • Behavioral analysis • Preprocessing – Motion correction – Normalizing – Smoothing • Statistical maps – Individual analysis: Which voxels correlate with the treatment, corrected for the homodynamic response? – Group analysis: Which voxels do so for “many” people. – One has to take into account that multiple tests are conducted (corrected and uncorrected p-values). • Time course in regions of interests (ROI-analysis).
    32. 32. Block design and event related design • Block design • A experimental condition A is repeated several times, then the condition B is repeated several times, … • Event related design • The experimental conditions A and B are presented on randomized order. • This is in particular the case, when the timing of experimental conditions is determined endogenously (free decision time). • Neuroeconomic experiments are usually event related, because the “stimulus” should unpredictable.
    33. 33. Comparison of PET and fMRI • Advantages of fMRI: – higher spatial resolution. – higher temporal resolution. – less invasive (no radioactivity). • Advantages of PET: – Silent (auditory stimuli). – Less movement artifacts when subjects speak. – Sensitive to the whole brain. fMRI creates artifacts' in the neighborhood of cranial cavities (Schädelhöhle) (forehead, ear). – Fewer repetitions necessary.  PET almost dominated by fMRI. Latter two point are potentially relevant for economic experiments.
    34. 34. Transcranial Magnetic Stimulation (TMS) • Allows “virtual lesions” • Non-invasive procedure: debated • A strong, magnetic impulse induces small currents (Ströme) in the brain (cortex). • These currents create neural activity. • Repeated stimulation at the same position can increase or decrease how strongly neuron respond.  Temporally and spatially limited inhibition or activation of the brain function.
    35. 35. Pharmacological Methods  Placebo controlled administration of substances inform about the functioning of neurotransmitter or hormone systems. • Neurotransmitter • Dopamine, Serotonin, Noradrenalin • Neurohormons • Oxytocin • Sexual hormons • Testosterone, Estrogen • Stress hormons • Cortisol
    36. 36. Other methods • Single Neuron Measurement – Implantation of electrodes into the brain – While fMRI measures „cumulative“ activity of thousands of neurons, each electrode measures a single neuron‘s activity – Very invasive, therefore used on humans only if neurosurgery inevitable due to epilepsy, and on animals • Psychopathology – Various illnesses have been associated with specific brain areas, some illnesses progress along a localized path in the brain – Chronic mental illnesses (schizophrenia), degenerative diseases of the nervous system (PD), developmental disorders (autism) – Inferences can be made about the role of specific brain areas in brain functioning
    37. 37. Overview of neuroscientific methods
    38. 38. Animal research • Many brain areas in humans and animals have similar structures. – It‘s possible to “produce” addicted rats. Addiction is created in that part of the brain which we share with other mammals. – Learning. – Decision taking in monkeys. • Creating lesions and single cell recording (i.e. measuring the electrical potentials of single neurons) is possible in non-human primates but not in healthy humans.
    39. 39. Controlled lesions • Allows to determine causally whether a particular brain region (or connection between regions) is essential for a particular function. • Examples: – Experimental destruction of both amygdalas in an animal tames the animal, making it sexually inactive and indifferent to danger like snakes or other aggressive members of its own species. – Knocking out the gene that makes a key protein for amygdala function makes rats relatively fearless.
    40. 40. Topics in Neuroeconomics: Preferences The following is taken from the Camerer et al. paper Neuroeconomics: Why Economics Needs Brains (Camerer, Loewenstein, Prelec, 2004, Scandinavian Journal of Economics) • Revealed preference approach cannot tell the whole story – Al and Naucia both refrain from buying peanuts at a certain price – Common disutility? – Al has a fatal allergy (inelastic demand) while Naucia once simply ate too many peanuts (would be willing to eat some again for a certain price) • Biological state-dependence vs. rational choice • There is no low enough price to induce Al buying peanuts • Tradeoff between „sleep utility“ and „risk of plowing into a tree utility“? – Dead sleeper with U(sleep)>U(plowing into tree)??? – Choice as a result from interaction of multiple systems (automatic biological system, controlled cognitive system)
    41. 41. Preferences • Preferences are state-dependent – Whether I like having icecreme depends on the season – Homeostasis (Gleichgewicht der Körperfunktion) • Different types of utility – Kahnemann: remembered utility, anticipated utility, choice utility, experienced utility – Different types do not always coincide – in particular for rare but important decisions – Contradictory to standard analysis of welfare, which assumes that choices anticipate experience perfectly – Examples: compulsive shoppers (revealing choice utility) buy stuff they don’t use (experience utility); children drug and addicts (craving/wanting; consumption/choosing; not pleasurable) – Presumption in neurosciences: different types of utility are produced in different brain regions
    42. 42. Preferences • Utility of money • Economics: People are expected to value money for what it can purchase -> indirect utility of income • Neuroeconomic evidence suggests that money can be directly rewarding -> direct utility of income – Monetary rewards seem to activate the same brain region (dopaminergic neurons in the midbrain) that is active for a wide variety of rewarding experiences • Possible explanation for why workaholics and very wealthy people keep working even though the marginal utility of goods purchased with their marginal income is very low • Pain of paying..., credit cards or preference for fixed payment plans rather than marginal-use pricing
    43. 43. Flat rates • Many studies show that consumers choose flat rates even though marginal use schemes would be “optimal”, i.e., cost less (telephone, fitness studio) • Explanations – Risk aversion (knowing the cost vs. uncertain cost) – Mental accounting and neuro perspective (pain of paying), see, e.g., Prelec/Loewenstein (1998) – They ask Ss whether they enjoy using different products more when paying flat rates or marginal use schemes: 48 percent prefer flat rate, only 19 percent prefer marginal use scheme (fitness studio, phone, traffic etc.) – Laziness – Overestimation effect (wrong subjective prob. of using a particular good) – Commitment device
    44. 44. Preferences • Source of income – Economics: utility of income is independent of its source • Neuroeconomic evidence: earned money is more rewarding than unearned money – Greater activity in the striatum (midbrain region) for earned income (Zink et al 2004) • Implications for welfare and tax policies? – Workfare vs. welfare
    45. 45. What is “better”: welfare or workfare? A little digression • Workfare programs introduced in several countries • Unlike regular public assistance, workfare requires recipients to spend time on mandatory activities such as community work • Economic theory predicts that workfare increases the incentive for benefit recipients to seek regular employment, because the work requirement reduces the attractiveness of being on public assistance • However, workfare is often claimed to be “unfair” • Can Neuroeconomics provide additional support?
    46. 46. This study (Falk, Huffman and Mierendorff 2006) 1. Study the incentive effects of workfare 2. Assess potential political support/resistance with respect to workfare – Explore motives behind voting for/against workfare
    47. 47. 1. Incentive effects • Real effort task – Task has no intrinsic value – Experiment captures essential tradeoff between effort cost and wage • Elicit reservation wages
    48. 48. Count the number of zeros: How many of these would you do for X Euro? Seite 1 1 0 0 1 0 1 1 1 1 1 0 1 0 0 0 1 0 0 0 0 0 0 0 0 1 0 1 0 1 0 1 0 0 1 1 0 0 0 0 1 0 0 1 1 0 0 1 0 0 1 1 1 0 0 0 1 0 0 0 0 0 0 1 0 1 1 0 1 0 0 1 1 1 1 1 1 0 1 1 1 0 1 0 0 0 1 1 1 0 1 0 1 0 1 1 0 1 0 0 1 1 1 0 0 0 0 1 1 1 1 1 0 1 0 0 0 1 0 0 1 0 0 1 0 0 1 1 1 1 0 1 0 0 0 1 0 1 0 1 0 0 0 1 0 0 0 0 1 0 1 1 1 0 0 0 0 1 0 1 0 1 1 1 0 1 0 1 1 1 1 0 0 0 1 1 1 1 1 0 0 0 0 0 0 1 0 1 0 1 1 1 1 0 1 0 1 1 0 0 0 0 0 0 1 0 0 0 0 1 0 0 0 0 1 1 0 0 1 1 1 0 1 1 0 1 1 1 1 0 0 0 1 0 1 0 1 0 0 0 0 1 0 0 0 1 0 0 0 1 0 1 0 0 0 0 0 0 0 0 1 0 1 0 1 1 1 0 0 1 0 1 0 1 0 0 0 1 0 0 1 1 0 1 1 0 0 0 1 1 0 1 1 1 0 0 1 0 1 1 1 Number of 0's ________ Sheet 1
    49. 49. Phases of the experiment • Phase 1: try the task • Phase 2: choice tables – Subjects fill in choice tables • Phase 3: work/payment – Subjects are paid and leave the lab, if on welfare – Subjects work if employed or on workfare • Paid and allowed to leave as soon as they are done
    50. 50. Example choice table Option 1 Option 2 I choose Option 1 I choose Option 2 4 Euro, 0 sheets 1 Euro, 10 sheets o o 4 Euro, 0 sheets 2 Euro, 10 sheets o o … … … … 4 Euro, 0 sheets 9 Euro, 10 sheets o o “welfare” “regular job”
    51. 51. Example choice table Option 1 Option 2 I choose Option 1 I choose Option 2 4 Euro, 9 sheets 1 Euro, 10 sheets o o 4 Euro, 9 sheets 2 Euro, 10 sheets o o … … … … 4 Euro, 9 sheets 9 Euro, 10 sheets o o “regular job”“workfare”
    52. 52. Work outcomes and payment • Subjects know how outcomes are determined: – One row in one table is randomly selected – Subject’s choice for that row is implemented • e.g. 4 Euros and leave the lab immediately • or, 6 Euros after completing 5 sheets – Incentive compatible – Payment conditional on completing required sheets; receive money and leave when finished
    53. 53. Results 0 1 2 3 4 5 6 7 8 5 10 number of sheets reservation wage (€) welfare workfare Incentive effects are significant 5 sheets (p<.0001) 10 sheets (p<.0051) Wilcoxon Rank test. Euro
    54. 54. 2. Political Acceptability • To what extent do people support workfare? – What are their motives? • We study this in a setting where some individuals, type A, must work and pay taxes to support individuals on welfare. • Other individuals, type B, choose whether to work, or to go on welfare and collect money from the A’s. • Before Ss know their roles, they vote on whether or not to attach a work requirement to welfare benefits – Voting behind the “veil of ignorance”
    55. 55. Phases of the experiment • Voting – Ss are assigned to groups of 3 – Each group consists of two A and one B – A’s will potentially earn 6 Euros for 10 sheets, or only 4 Euros if B does not work (welfare support) – Ss vote whether to impose a work requirement, if B chooses not to work • Types are revealed and B’s make a choice: – Work, and earn 6 Euros by doing 10 sheets – Receive 4 Euros from the A’s, potentially for 0 sheets • Work and payment – Ss on welfare are paid and leave immediately – Ss who are employed, or on workfare, begin work – Ss are paid and can leave as soon as they have completed the required task units
    56. 56. Summary of possible outcomes B outcome A outcome B earns money 6 Euro, 10 units 6 Euro, 10 units B chooses not to work Welfare 4 Euro, 0 units 4 Euro, 10 units Workfare 4 Euro, 3 units 4 Euro, 10 units
    57. 57. Is Workfare Fair?
    58. 58. Substantial support for workfare Voting decision (N=73) Workfare, 84% Welfare, 16% All groups implement workfare; among 23 B-players, 20 choose “regular job”
    59. 59. Why do people support workfare? Categorized responses to free-form questions. Self-interest: workfare gives B an incentive to work. Social motives: inequity aversion, fairness, reciprocity Social Motives 56% Both 15% Self-Interest 16% Welfare 16% Other 13% Self Interest 16% Both 15% Social Motives 56%
    60. 60. Conclusions/end of digression • Workfare has the predicted impact on reservation wages • We find substantial support for workfare (importance of fairness) • Neuroeconomics relevant? – Revenge is sweet (people like to punish defectors, see deQuervain 2006): may be one reason why people vote in favor of workfare – People are better off if they receive money as a return for working (Zink et al. 2004)
    61. 61. Preferences • Addiction – Models of rational addiction: current utility depends on a stock of previous consumption, consumers understand the habit formation and respond to future prices – The rational addict should buy drugs in large quantities at discounted prices and self-ration them • Is addition rational? – Many addicts quit and relapse regularly – Buy small packages: struggle of two systems? – Neuroeconomic evidence: addictive substances seem to initiate the reward mechanism in the „old“ part of the human brain – Substances also potentially addictive for rats – No contradiction of rational model, but shows that rational planning not necessary to create addictive phenomena
    62. 62. Decision-making under risk and uncertainty Risk and ambiguity • Economics: risk is equated with variation of outcomes: one- dimensional • Neuroeconomic evidence: risk has more than one dimension – Potential catastrophic outcomes that are difficult to control are perceived as more risky (controlled for statistical likelihood) -> fear of flying – Driven (amongst others) by fear responses (amygdala) – „Ambiguity“: missing information about probabilities people would like to know but don‘t • Activation of insula is different when people choose certain money amounts compared to when they choose ambiguous gambles (insula processes information like physical pain, hunger, pain of social exclusion,…)
    63. 63. Decision-making under risk and uncertainty Risky choice • Involves an interplay of cognitive and affective processes • Experimental evidence: – Two groups of subjects: „normal“ subjects and subjects with prefrontal cortex (PFC) damage (i.e. a disconnection between cognitive and affective system) – Subjects repeatedly had to draw cards from different decks (different with respect to expected value, range of outcome), learned the composition of decks via trial- and-error. – Skin conductance reactions (fear) to large losses identical among both groups – „Normal“ subjects learned to avoid risky „bad decks“ while prefrontal-damage patients returned to bad decks shortly after experienced losses – Imaging studies show that gains and losses produce different levels of activation in different regions of the brain – Support for prospect theory (Kahnemann/Tversky)
    64. 64. Decision-making under risk and uncertainty Gambling • Economic puzzle: people both demand insurance and gamble at the same time – Including emotions and other neuroscientific insights might help – Studies of “pathological” gamblers: genetic disposition; mainly male – Blocking of opiate receptors in the brain reduces the urge to gamble
    65. 65. Game theory and social preferences • Assumption among neuroscientists: there is a specialized „mind-reading“ area in the human brain, that controls reasoning about what others believe and might do • Social preferences – Cooperating subjects show increased activation in Broadmann area 10 (“mind reading area”), autists are assumed to have deficits in that area and often have trouble figuring out what other people think and believe – Sanfey, Rilling et al.: fMRI study of ultimatum bargaining: see above
    66. 66. Concluding remarks • Neuroscience measurements offer more reliable and unbiased data in many cases (e.g., compared to certain survey data or self-reports) • Neuroeconomic research might give better insights for example into consumption choices and underlying mechanisms, nature of behavior; studying unobservable intermediate variables (beliefs, utility) • Neuroscience can possibly show that economic choices that are considered to be different in economic theory but that use the same brain circuitry (e.g., insula cortex is active when subjects reject low offers in ultimatum game and when choosing an ambiguous gamble) • Neuroscience can add precision to functions and parameters in standard economic models
    67. 67. Final comment • Neuroeconomics is important and will stay if it produces scientifically valuable knowledge • This is true irrespective of whatever notion someone holds of “what economics is about”
    68. 68. Unfair pay and Stress (Falk, Menrath, Kupio and Siegrist, 2008) • Does perceived unfair treatment induce stress? • Important to understand nature of social preferences – Negative emotions and stress caused by unfair treatment are hypothesized to be a main reason for reciprocation (Adams 1964, Fehr 1999, Falk and Fischbacher 2006); reduced by the act of reciprocation (see recent neuro-imaging evidence, see beow) • Enhances our understanding of the effects of income inequalities, which are widening in modern western economies – Unfair pay may adversely affect work motivation, well- being and health status of employees (questionnaire studies, epidemiological studies)
    69. 69. Health and the workplace • Specific features at the workplace enhance or reduce employees’ health through psychosocial stress-related mechanisms – These features are related to firm organization, modes of payment etc. • Hypothesis: Effort-reward imbalance (unfairness) at work increases the risk of stress-related diseases (e.g. coronary heart disease, depression) and health-adverse behaviors (smoking, alcohol). “By the year 2020 depression and coronary heart disease will be the leading causes of premature death and of life years defined by disability ... worldwide.“ (WHO and Murray and Lopez 1996)
    70. 70. Design • Stylized labor relation, one principal one agent • Details of the experiment are all commonly known • Agent produces revenue by working on a tedious task – Counting zeros on sheets with zeros and ones – 3 Euro for correct number; 1 Euro for almost correct number (deviation of plus/minus 1); zero Euro otherwise – Agents work 25 minutes; principals do not work at all • Total revenue goes to the principal who allocates it between himself and the agent • Before agent gets to know his share, he is asked about a pay he would consider as appropriate • After agent is informed he has four minutes to think about a letter he would write to his principal • These four minutes are used to recorded heart rate variability of agents (relative to baseline)
    71. 71. Heart rate variability • Heart rate variability has been chosen as a physiological marker in our experiment because of its sensitivity to recurrent experience of emotional stress • Recent evidence from epidemiological investigations indicates that HRV is an early indicator of functional and structural impairments of the cardiovascular system, which increases the probability of future manifest coronary heart disease • HRV is low if stress is high
    72. 72. Three measures of unfairness • Actual share = payoff of agent/total revenue • Discrepancy = actual share/appropriate share • Fairness on a 5-point Likert scale
    73. 73. Results Variable Mean Standard Deviation Revenue produced by agents (Euro) 20.9 8.57 Actual share 0.43 0.14 Appropriate share 0.63 0.16 Discrepancy 0.69 0.29 Fairness Questionnaire (1-5) 2.56 1.43 Table 1. Descriptive statistics: mean and standard deviation (SD) for each variable included in the analysis (N= 30 subjects)
    74. 74. QuickTime™ and a TIFF (PackBits) decompressor are needed to see this picture. Figure 1: Discrepancy between actual and appropriate share received by agents. Actual share is defined as ratio between actual payment and total revenue; appropriate share is defined as ratio of appropriate payment and total revenue. The line is a 45-degree-line.
    75. 75. QuickTime™ and a TIFF (PackBits) decompressor are needed to see this picture. Figure 2(a): Relation between actual share and heart rate variability (RMSSD). The line is a weighted regression line.
    76. 76. QuickTime™ and a TIFF (PackBits) decompressor are needed to see this picture. Figure 2(b): Relation between discrepancy and heart rate variability (RMSSD). Discrepancy is defined as ratio between actual and appropriate share. The lower the value for discrepancy the larger is the discrepancy between actual and appropriate shares. The line is a weighted regression line.
    77. 77. QuickTime™ and a TIFF (PackBits) decompressor are needed to see this picture. Figure 2(c): Relation between fairness questionnaire measure and heart rate variability (RMSSD). Fairness is measured on a 5 point Likert scale. The line is a weighted regression line.
    78. 78. Dependent variable: Heart rate variability (RMSSD) Actual share 38.17** [12.77] Discrepancy 18.87** [6.29] Fairness 4.13** [1.26] Constant 15.84* 19.35** 21.72** [5.81] [4.69] [3.69] Observations 30 30 30 R-squared 0.24 0.24 0.25 Supplemental Table 1: Heart rate variability regressions. OLS regressions with standard errors in brackets. * indicates significance at 5%; ** at 1%.
    79. 79. Actual share Discrepancy Fairness 0.70** 0.79** Mood 0.56** 0.59** Anger - 0.58** - 0.70** Supplemental Table 2: Correlations of experimental and questionnaire measures. Spearman rank correlations. ** indicates significance at 1%; Number of observations = 30.
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