IT’S ALL IN THE MIND: THE NEUROECONOMICS OF DECISION MAKING

By Tanisha Kamat | Edited by Ikshita Jain

“We could solve all our problems if only we were the efficient, rational human beings of standard economic theory,” said Jeremy Grantham, British investor, and CEO, as he challenged the very base of every modern economic theory: a purely rational human being. Unfortunately, today’s neuroscience tends to support Grantham’s speculations, stating that humans are often not rational economic actors that economists up till now assumed them to be. This ground-breaking discovery created tremors in the economic world. With rationality out of the picture, supply and demand slope incorrectly and uncertainty plays a much bigger role in decision-making. In order to correct these assumptions in their models, economists have now turned to psychology and neuroscience. British neurologist Francis Circk states that “A person’s mental activities are entirely due to the behavior of nerve cells, glial cells, and the atoms, ions, and molecules that make them up and influence them.” implying that all of a person’s experiences are actually ‘in their mind’. This encouraged neurologists and economists to come together and form a unified theory of how the mind makes decisions under uncertainty. 

Most of the uncertain decisions are undertaken in the frontal lobe of the brain. The brain centers in the frontal lobe are in charge of higher-level thinking such as problem-solving, reasoning, making judgments, making plans for the near and far future, making choices, taking action, solving problems, etc. Sounds similar to challenges every investor faces, doesn’t it? So let’s take an example: Suppose you have to make a decision of whether or not to invest in cryptocurrencies. If you seek to gain profit from your potential investment, your nucleus accumbens, the human center for pleasure, will flood your brain with dopamine, the happy hormone. If the risk associated with your investment is high and it turns into the fear of loss, then the fear center – the amygdala – is activated. This can make you quit your investment. It is your brain’s CEO, the prefrontal cortex, that manages these forces: The pleasure center (Nucleus Accumbens) and the fear center (Amygdala). The prefrontal cortex acts as a mediator, so instead of acting purely on the pleasure or fear (emotions) triggered by the nucleus accumbens or the amygdala, the prefrontal cortex gives us the opportunity to deal with the situation more rationally. Thus, you proceed to collect more information about your investment before making a decision. This search for more information is seconded by the amygdala as it is conditioned to avoid decisions with incomplete information. 

This means that given two equal options, one with complete information and one with incomplete information, the amygdala will most likely choose the one with more information even though orthodox economics will be indifferent between them. Thus, the amygdala will make you choose a cryptocurrency that you are familiar with rather than one you have never heard of, because you have more information about that cryptocurrency, which makes your brain more comfortable with the investment. Another important area of the brain involved in uncertain decision-making is the insula. The insula lies hidden under the layers of brain tissue. Its anterior part especially plays a very important role when dealing with money. It is responsible for feelings of anxiety, suspicion, anger, and negativity. These very emotions save people from making risky financial gambles. Thus, the insula warns you against too-good-to-be-true schemes by giving you a feeling of uneasiness. When you finally find a scheme that satisfies your amygdala and insula, the nucleus accumbens gives your prefrontal cortex a green signal, and PFC in turn orders your motor cortex to execute your decision. Congratulations, you just made a decision! 

After explaining how an individual mind makes decisions, Neuroeconomics moves forward to explain how multiple minds make decisions. Game theory, or strategic decision-making, involves making decisions that depend on the decisions of others. As with most economic models, it assumes that people will only choose what works best for them, regardless of others. But neuroeconomists point out that people aren’t as self-centered as traditional economists think. Oxytocin is a powerful hormone that “rises during social bonding” and is given as a reward for connecting with other players. It acts like a biological factor that encourages players to think about the interests of others alongside their own interests. This may encourage them to abandon their drawers and show trust and cooperation. Evidence of this was found in the classic prisoner’s dilemma when neuroeconomists discovered a possibility that the prisoners will collaborate, even if it’s not intentional because they are biologically inclined to help their fellow human beings. This discovery provided rays of altruism to an otherwise narcissistic discipline. 

Despite these impressive accomplishments, neuroeconomics has yet to demonstrate a critical role in neuroscience, psychology, and economics. In recent years, brain-imaging techniques have enabled researchers to provide more specific insight into vaguely defined topics and their assumptions. Neuroeconomics proved that people tend to be overactive to risk and uncertainty and that strategic players are not always rational and selfish. Such discoveries upset the orthodox economic framework, which is dependent on an assumption of self-interested “rationality.” Thus, traditional economists criticize neuroeconomics stating that ‘it misunderstands and underestimates traditional economic models.’ However, neuroeconomics is at its best, a decade old and faces a lot of criticism. The work in the neuroscience of decision-making holds the potential to shape interventions that may revolutionize the economic understanding of human behavior. 

References:

Tomer, J. F. (2012, December 6). Economic decision making: How our brain works. SSRN. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2185974

Dhanuka, A. (2021, April 15). Neuroeconomics – the answer to rational decision theory? Youth Policy Review. https://www.youthpolicyreview.com/post/neuroeconomics

Goel, A. (2022, January 8). Neuroeconomics: The Chemistry of Rationality. Michigan Journal of Economics. https://sites.lsa.umich.edu/mje/2022/01/13/neuroeconomics-the-chemistry-of-rationality/

 Padoa-Schioppa, C. (2011). Neurobiology of economic choice: A good-based model. Annual review of neuroscience. https://www.ncbi.nlm.nih.gov/pmc/articles/PMC3273993/

 Mateu, G., Monzani, L., & Navarro, R. M. (1970, January 1). The role of the brain in financial decisions: A viewpoint on neuroeconomics. Mètode Science Studies Journal. https://www.redalyc.org/journal/5117/511766757004/html/

 Krajina, A. (2017, December 11). How our brain influences investment decisions. tritra. https://tritra.eu/the-why-and-how-behind-financial-decision-making/

 Knutson, B., & Bossaerts, P. (2007, August 1). Neural antecedents of financial decisions. The Journal of neuroscience: the official journal of the Society for Neuroscience. https://www.ncbi.nlm.nih.gov/pmc/articles/PMC6673081/

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