The Neuroscience of Economics

The field of neuroeconoimcs has become a popular realm of study in recent years due to advances in neuroscience.  Many ground breaking discoveries are already being employed in our everyday lives. But what you really want to know is ‘how does this help me?’ Here are some useful tips and tricks to utilize for yourself in the business world and beyond. 

The Right Price

Neuroscience has shown that there is asymmetry between gains and losses because they activate different areas of the brains, specifically different areas of the ventromedial prefrontal cortex. There is no change in dopamine release from an unexpected loss in the ventral striatum which is the area most effected by unexpected gains.  This suggests that losses utilize a different neural pathway than gains and they are encoded in different sections of the brain. Losses are shown to be coded in other areas such as the insula and the amygdale, which are also associated with intense emotions such as fear. This appears to be the underlying reason behind our inherent loss aversion.

Knowing that brain codes gains and losses in a different way, this information can be used to gain an advantage through simple phrasing.  When attempting to determine a price from a consumer, there are two methods you can use: Willingness to Pay (WTP) and Willingness to Accept (WTA).  For example, if people are to give a value to their environment, they could be asked either how much they are WTP to keep something intact (say clean air) or how much they would be WTA (say an increase in polluted air). However, people’s WTA is not equal to WTP because people do not value gains and losses equally. WTA prices have been shown to be close to 60%higher than WTP prices, meaning it costs far more for people to be willing to accept a decrease in their air quality than they would be willing to pay for clean air. WTA invokes loss aversion because it makes people see the natural resources as if it’s being taken away from them.

Quit While You’re Behind

Everyone wants a good track record when it comes to their earnings portfolio, but studies have shown that obsessing over losses can lead to an even deeper plunge in earnings. The problem is people hate to lose even more than they like to win by the same amount so they will hold onto their losses in hope that they will again become winners and will not have to face the loss. An unrealized loss will not cause the negative neural reaction as actually selling the losing stock and realizing the loss. But holding onto these losers can damage your portfolio, so if the situation warrants a sale; just sell.

Status Quo Bias

Going through stacks of paper work can be monotonous, so when faced with a question that seems to already have an answer (one with a default option) it is often mistaken as a no-brainer. People tend to pick whatever the default option is because of the status quo bias. This means they want to choose the option that they think everyone else is choosing because it is probably the best choice. Knowing this, you can avoid or utilize this virtually instinctual reaction. By changing the defalult option you can alter the frame of the question to have the prefered option be the default.

Morality over Market

Market norms are extrinsic to the individual and are based on the assumption of the standard economic model that people act purely selfishly and have no social preference in terms of reciprocity. Social norms on the other hand involve intrinsic values that people have and are shaped by a person’s individual psychological make-up and by the culture in which the person operates. These norms are important for public policy because some policies designed to achieve certain ends may actually prove to be counterproductive due to the phenomenon of crowding out of intrinsic incentives. The provision of external market-based norms in a transaction may replace pre-existing social norms and change the incentive structure of behavior in an unintended way. The most famous example of this is in a child day care center when the care takers wanted the parents to stop being late. So, they imposed a fine for late pick-ups. And what happened? Parents began to arrive even later. It turns out the parents found it easier to buy off their guilt of being late then face the social ostracism of being called a negligent parent. Thus, the day care center unintentionally ending up offering morality for purchase, which parents decided was well worth their money.

These are just a few fascinating insights into the fast-pace world of Neuroeconomics. Hopefully they will be of some use for you.

Leah Tobin

Pitzer College

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