EC345|Behavioural Economics:

Theory and Applications

Week 4: Neuroeconomics
Dr Mahnaz Nazneen
 Introduction

Methods and Tools

Outline
The Dual Brain System

Empirical Examples
Introduction
• Neuroeconomics combines methods from neuroscience and economics to better
understand how the human brain generates decisions in social and economic
contexts
• It is the study of the biological micro-foundations of economic cognition – David
Laibson
• Biological micro-foundations 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 behaviour.
• helps to disentangle the complex interrelationships between the neural
mechanisms with which evolution has endowed our brains, the mechanisms that
our brains have built into our external institutions, and the joint computations of
these mechanisms from which social and economic outcomes emerge
Economics vs. Neuroeconomics

• Models in Economics (including Behavioural Economics) are developed

based on a paradigm of rationality
• These models are black box models: working on an “as if” assumption
• (e.g., “as if” individuals are rational, “as if” they have hyperbolic
preferences, etc.)
• traditionally records people’s choices and generates mathematical
models to make predictions
Economics vs. Neuroeconomics

• Neuroeconomics on the other hand makes use of data on the process by

which choices are made
• adds observations of the central and peripheral nervous system to
the explanatory variables
• aims to determine the physiological basis for the observed anomalies in
the rational model of neoclassical economics
• possible to pursue the investigation of the reasons for fallacies, in an
effort to improve human decision making
General Process- Example
• Game theory is used extensively in neuroeconomics studies as it allows to
interpret observed behaviour/ outcome through a precisely defined strategic
mechanism
• For example, I want to study the process by which an individual chooses to
cooperate
i. Locate correlates of economic concepts in the brain (e.g., empathy/cooperation)
ii. Run a behavioral experiment to get people to exhibit the desired behaviour (e.g.,
preference for cooperation- in a classic Prisoner’s Dilemma game)
iii. Observe/scan brain while they are doing so
iv. Find areas of brain whose activity correlates with behaviour
v. Conclude that this is where the related preference lives (in the brain)
 Why study Neuroeconomics?

It may help us answer questions such as these:

• Are components of behavioral models represented in brain structures?
• Can insights into how the brain works improve economic modelling?
• Can those insights discriminate between alternative models?
It can also help us:
• direct and catalyse the development of new models, speeding up the rate
of progress in model development
• eventually be able to use neuroscience measurements to help people
better understand and manage themselves
Methods and Tools
1. Brain imaging methods
• this process involves taking pictures (images) of an active brain. Most common
tools used are:
• Positron emission tomography (PET)
• electro-encephalogram (EEG)
• functional magnetic resonance imaging (fMRI)
 1.1 Electro-Encephalogram (EEG)

• Measures electrical potentials at the scull,

caused by neural activity
• Limitations:
• Large number of repetitions of the same
situation is necessary
• Eye movement also creates electric
activity
• In some regions neurons are not aligned
and activity can cancel out
• Not well suited for most economic
experiments
1.2 fMRI (Functional Magnetic Resonance
Imaging)
• fMRI uses the fact that haemoglobin (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, the fall in oxygen is
overcompensated for when oxygen-rich blood moves to the activated area
• Costly and non-natural experimental environment
fMRI (Functional Magnetic Resonance Imaging)
DARTMOUTH SOCIAL NEUROSCIENCE LAB
General Process
• 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 behaviour
2. Pharmacological Methods
• studies involve administering a drug that blocks (an antagonist) or stimulates (an
agonist) a particular kind of neurotransmitter receptor→ compare behavioural
performance on and off the drug
• used to test the necessity and sufficiency of neurochemical systems for mental
processes
• For example:
• Neurotransmitter (Dopamine, Serotonin)
• Neurohormones (Oxytocin)
• Sexual hormones (Testosterone, Estrogen)
• Stress hormones (Cortisol)
3. Transcranial Magnetic Stimulation (TMS)
• technology that temporarily alters/disrupts normal cognitive functioning in a
localized region of the brain
• non-invasive method which involves placing an electromagnetic coil on the
scalp. A pulse generates a magnetic field and induces a current which results in
neural activity
• produce transitory 'virtual lesion‘ effects which could help to understand how,
when and where cognitive tasks are performed
4. Study of animal models
• Many brain areas in humans and animals have similar structures (e.g., rats/
monkeys)
• 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
5. Analysis of patients with neural anomalies
• 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
6. Markers
• neural features may be suitable as relatively stable biomarkers for different
decision traits
• The establishment of such markers may improve the prediction of economic
behavior across different contexts
• Different tendencies in decision making, such as tolerance for risk, delay or effort,
have been linked to various neurobiological measures, such as morphometry,
structural connectivity, functional connectivity or the function of
neurotransmitter systems
7. Others Methods
• Cognitive load manipulation
• response time measurements
• eye tracking
• single-neuron measurement
• genotyping
• gene expression etc.
Common Limitations
Limited and non-representative sample (e.g., human with lesions)

Non-human may respond differently than human

Limited capacity of interventions, potential health issues for subjects (e.g.,

pharmacological interventions)
Markers are not always precise and limited field of application

Costly and non-natural experimental environment (e.g., fMRI scans)

Multiple Systems Hypothesis
A Dual Brain System
Multiple Systems Hypothesis

The brain makes decisions (e.g.,constructs value) by integrating signals

from multiple systems

These multiple systems process information in qualitatively different

ways and in some cases differentially weight attributes of rewards
Example:
Example:
Multiple System Hypothesis: similar concepts
Controlled vs Cold vs Hot
Interests vs passions Superego vs Ego vs Id
Automatic (Benhabib (Metcalfe and
(Smith) (Freud)
& Bisin, 2004) Mischel, 1979)

System 2 vs System 1 Deliberative vs Conscious vs

Effortful vs Effortless
(Frederick and Impulsive (Frederick, Unconscious
(Baumeister)
Kahneman, 2002) 2002) (Damasio, Bem)

Planner vs Doer Patient vs Myopic Abstract vs Visceral

(Shefrin and Thaler, (Fudenburg and (Loewenstein &
1981) Levine, 2006) O’Donoghue 2006)
Brain System
• Affective system
• fast
• unconscious
• myopic
• effortless
• Analytic system
• slow
• conscious
• forward-looking
• self-regulatory
• effortful and exhaustible
Empirical Application-1
Emotional and cognitive process in fairness
Example 1 Sanfey et. al. (2003)
• interested in neural and behavioral reactions to offers which are fair or unfair
• hypothesized that unfair offers would engage neural structures involved in both
emotional and cognitive processing
• the magnitude of activation in these structures might explain variance in the
subsequent decision to accept or reject these offers
Example 1 Sanfey et. al. (2003)
• Ultimatum game
• Player A has $10
• Makes an offer to player B of the form: I will take x and you take $10-x.
• Player B can either accept offer, or reject offer in which case both get $0
• Responder’s brain activations are measured by fMRI- 19 participants
Example 1 Sanfey et. al. (2003)
• A responder faces each of three conditions ten times
• Offers from a (supposed) human partner
• Random offers from a computer partner
• Control conditions (offer from a button press)
• Research Questions: Which brain areas are more activated when subjects face. . .
• fair offers (3 or 5) relative to unfair offers (1 or 2).
• the offer of a human proposer relative to a random computer offer
Example 1 Sanfey et. al. (2003)
Experiment Design
 Example 1
Sanfey et. al.
(2003)
Example 1 Sanfey et. al. (2003)
Recall- general process- Locate correlates of economic concepts in the brain
• 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
 Example 1 Sanfey et. al. (2003)
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 offers is compared to unfair random offers)
Example 1 Sanfey et. al. (2003)

• Unfair offers are more likely

to be rejected if insula
activation is stronger.
• Figure: Acceptance rates of
unfair offers plotted against
right anterior insula
activation
Example 1 Sanfey et. al. (2003)
• areas of anterior insula and DLPFC represent the twin demands of the Ultimatum
Game task
• the emotional goal of resisting unfairness and
• the cognitive goal of accumulating money
• activity in a region well known for its involvement in negative emotion is
predictive of subsequent behavior
• supports the importance of emotional influences in human decision-making
Empirical Example-2
Application of neurohormone in social preference (trust)
Example 2 Kosfeld et. al. (2005)
• “Oxytocin increases trust in humans”
• Oxytocin is a hormone, which induces labour in human and nonhuman mammals,
during lactation of young animals and during mating.
• Oxytocin is conjectured to play a key role in different social behaviours
• Conduct a placebo-controlled hormone study that isolates the specific impact
• this provides causal information about the impact of the hormone
 Example 2 Kosfeld et. al. (2005)

• 2 subjects play either the role of an investor or a

trustee
• Both receive an initial endowment of 12 monetary
units (MU)
• investor can send 0, 4, 8 or 12MU to the trustee
• experimenter triples each MU the investor transfers
• the trustee has the option of sending any amount
between zero and his total amount available back
to the investor (E.g., if the investor has sent 12MU,
the trustee possesses 48MU (12MU own
endowment + 36MU tripled transfer)
• Trustee can choose to transfer back any amount
from 0 to 48MUs
Example 2 Kosfeld et. al. (2005)
• Hypothesis:
• oxytocin increases the trusting behaviour of investors
• investors in the oxytocin group will show higher money transfers than those in
the placebo group
• Results:
• 45% in the oxytocin group showed the maximal trust level, (only 21% in the
placebo group showed maximal trust )
• 21% of the subjects in the oxytocin group had a trust level below 8 monetary
units (MU), but 45% of the subjects in the control group showed such low
levels of trust
• The investors’ average transfer is 17% higher in the oxytocin group
Example 2
Kosfeld et. al.
(2005)

Does Oxytocin affect

investor behaviour
 Is this because of the risk?

a social interaction with a specific

trustee constitutes the risk
Example 2 Kosfeld et.
al. (2005)

conducted a risk experiment in which the

investor faced the same choices as in the
trust game but in which a random
mechanism determined the investor’s risk.
 • the investors’ behaviour does not differ between the oxytocin and the
placebo groups
Example 2 Kosfeld • only the investors in the oxytocin group of the trust experiment behave
et. al. (2005) differently
• oxytocin increases the investors’ transfer levels in the trust experiment but
not in the risk experiment
Example 2 Kosfeld et. al. (2005)
• Does Oxytocin affect investor behaviour?
• Yes, oxytocin specifically affects trust in interpersonal interactions
• risk experiment constitutes a powerful control for the effects of oxytocin on
trusting behaviour
• investors’ risk in the risk experiment is not generated through a social
interaction
• all the indirect effects of oxytocin on the state of a subject, such as possible
effects on mood or calmness, would be present in both the trust and the risk
experiment
Voxels

• The 3-dimensionsal image of a fMRI is built up

in units called voxels. Each one represents a
tidy cube of brain tissue—a 3-D image
building block analogous to the 2-D pixel of
computers screens, televisions or digital
cameras. Each voxel can represent a million or
so brain cells. The light up blobs in the images
are clusters of voxels—tens or hundreds of
them.

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