Neuroeconomics is an emerging field in behavioral economics, combining economics, psychology, and neuroscience. It seeks to understand the complexity of the brain, previously the unknown ‘black box,’ and the impact of its substructures in economic decision-making.
By Minaal Adnani
According to the fathers of behavioral economics, Daniel Kahneman and Amos Tversky, there are two systems of cognition – the affective and the analytic systems. In their book, Thinking, Fast and Slow, we learn about System 1, which is the affective system where the brain forms thoughts in a fast, myopic, unconscious and reflexive manner. In contrast, System 2 is responsible for “thinking slow,” which is analytic cognition and revolves around slow, conscious, reflexive and forward-looking decisions. This difference can be understood by thinking of ‘System 1 thinking’ as somebody asking you,”What colour is your shirt?”, versus a “System 2 thought” that could be somebody asking you,”What do you think about the election?”
This is important because research in neuroeconomics has found different brain regions that are responsible for each of these systems. Affective cognition is located in the mesolimbic dopamine reward system. This pathway releases the neurotransmitter dopamine, which affects motivation for rewarding stimuli and pleasure. Human beings are known to seek instant gratification, so the role of dopamine in “thinking fast,” is an appropriate finding.
On the other hand, the frontal and parietal cortex have been linked to the analytic system of decision-making. The function of the frontal cortex is to mediate between current actions and future consequences. Such a region controls our higher-order thinking and complex reasoning. These brain structures are congruent with the workings of the analytic system of thinking.
The specialization and separation of brain function for decision-making gives rise to the multiple systems hypothesis. The information from the multiple systems – mesolimbic pathway, frontal cortex, and parietal cortex – are combined to produce our decisions. However, the rewards associated to different decisions cause greater weight to be associated to signals from each system.
Now, another term from behavioral economics known as hyperbolic discounting ties in with this research. This is the tendency for people to prefer smaller rewards sooner, compared to larger rewards later. As irrational human beings, we have a problem with the delay of gratification and prefer instant rewards. With this in mind, this must mean that the mesolimbic pathway is more impatient than the fronto-parietal system. The mesolimbic pathway discounts rewards at a higher rate than the prefrontal cortex.
When people must make decisions that involve intertemporal choice – how to act between various points in time – the difference in the impact of these two different systems become apparent. In a study, participants were asked to choose between a $20 Amazon giftcard now and a $30 giftcard in two weeks. More often than no, participants choose $20 right away because the mesolimbic pathway is most active and this reward provides instant gratification. Comparatively, the choice between $20 in four weeks or $30 in six weeks results in people choosing $30 in six weeks because both choices require the person to wait for the reward. In both situations, the participant would have to wait two extra weeks for the extra $10, but the person chooses a different reward in both because of the time dimension involved. In long-term decision-making, the analytic system supersedes the affective system and the prefrontal cortex is activated.
These findings show two distinct systems involved in economic decision-making and provide evidence for our strictly irrational choices. Furthermore, theories such as intertemporal choice and hyperbolic discounting are connected with our brain activity and the inner workings of our neural pathways. This has allowed us to gain a better understanding about the neural processes that underlie our decisions. However, the applications of this are being explored in the subfield of neuromarketing. Studies that present people with certain stimuli aim at revealing consumer preferences, which can then be used by companies to more effectively brand and market their products.
Research by Monica Wadhwa and Kuangjie Zhang has found the rounded price effect, which uses the intuition of system 1 and system 2. Setting the price of a product to a round number engages a consumer’s feelings because it is quicker to process; this is system 1. Therefore, a product that is marketed using emotions or imagery should be priced with a round number. In contrast, when marketing a good that highlights the features and benefits of that product, a nonrounded figure should be used. This is because a complex number requires more processing time and uses our cognition in a purchase decision.