Home' Technology Review : May 2005 Contents 74
T assumes that hu-
man beings behave rationally. That is, that they
understand their own preferences, make perfectly
consistent choices over time, and try to maximize
their own well-being. This peculiar assumption
has its roots in dusty essays like "Exposition of a New Theory on
the Measurement of Risk" (from 1738) by Daniel Bernoulli and
scholarly tomes like Theory of Games and Economic Behavior
by John von Neumann and Oskar Morgenstern (published in
1944). The idea has some validity: traditional economic theory is
good at predicting some market behaviors, such as how the de-
mand for products like gasoline will change after a tax hike. But
it s not very good at describing more-complex phenomena like
stock-price uctuations or why people gamble against the odds.
The problem, of course, is that people don t always behave ra-
tionally. They make decisions based on fear, greed, and envy.
They buy plasma TVs and luxury vehicles they can t a ord. They
don t save enough for retirement. They indulge in risky behavior
such as gambling. Economists understand this as well as anyone,
but in order to keep their mathematical models tractable, they
make simplifying assumptions. Then they try to adjust their
equations by adding terms that account for "irrational" behavior.
But if economists could develop models that accounted for the
subtleties of the human brain, they might be able to predict com-
plex behaviors more accurately. This, in turn, might have any
number of practical applications: investment bankers could
hedge against nancial euphoria like the Internet boom; adver-
tisers could sell products more winningly.
The idea that understanding the brain can inform economics
is controversial but not new; for 20 years, behavioral economists
have argued that psychology should have a greater in uence on
the development of economic models. What is new is the use of
technology: economists, like other researchers, now have at their
disposal powerful tools for observing the brain at work. The most
popular tool, functional magnetic resonance imaging (fMRI),
has been around since the late 1980s; but only in the past few
years has it been used to study decision-making, which is the
crux of economic theory.
The result is the emerging eld of "neuroeconomics." A urry
of recent papers in scienti c and economic journals---reviewed in
the Journal of Economic Literature by Caltech economics profes-
sor Colin Camerer and colleagues---shows how researchers are
using the neural basis of decision-making to develop new eco-
nomic models. At the January meeting of the American Eco-
nomic Association, the world s largest economics conference,
the neuroeconomics sessions were reportedly standing room
only. The hope seems to be that biological research will nally
help economists make sense of irrationality.
Take recent brain-imaging experiments by Princeton Univer-
sity psychologist Samuel McClure. In the journal Science,
McClure and colleagues report that when subjects choose short-
ter m monetary rewards, di erent regions of the brain are active
than when they choose long-ter m ones. People don t "discount"
future rewards according to a simple scheme, as many econo-
mists have suggested. It seems the brain actually makes short-
ter m and long-term forecasts in di erent ways. The challenge
for economists lies in translating this sort of scienti c insight
into, say, predictive models of how people plan purchases or
make retirement fund decisions.
This Is Your Brain on Money
"Addiction and Cue-Triggered Decision Processes"
By B. Douglas Bernheim and Antonio Rangel
The American Economic Review, December 2004
"Neuroeconomics: How Neuroscience
Can Inform Economics"
By Colin Camerer, George Loewenstein, and Dražen Prelec
Journal of Economic Literature, March 2005
"Neurally Reconstructing Expected Utility"
By Brian Knutson and Richard Peterson
Games and Economic Behavior (in press)
"The Adaptive Markets Hypothesis: Market Efficiency from
an Evolutionary Perspective"
By Andrew W. Lo
The Journal of Portfolio Management, 30th Anniversary Issue, 2004
"Separate Neural Systems Value Immediate and
Delayed Monetary Rewards"
By Samuel M. McClure, David I. Laibson, George Loewenstein,
and Jonathan D. Cohen
Science, October 15, 2004
The Economics of Brains
A collection of research papers touts the promise of neuroeconomics.
BY GREGORY T. HUANG
Our reviews use any artifact---a book, a product, a government report,
a movie, a research paper---as the occasion for a contemplative essay
on some technological controversy.
78 How the Fed Lear ned to Love Technology
81 Greenhouse Gas
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