Applications of Neuroeconomics

What is Homo Economicus?

Homo Economicus, literally meaning the economic man, is a basic concept referring to the way that economic actors, people, make economic decisions. Homo Economicus describes all people as “being rational and broadly self-interested actors with the ability to make their own judgments and decisions toward a desired end.”[1] Making rational decisions and acting self-interested, in this case, means making decisions that leave the actor better off than they originally were, regardless of others. Gaining the highest amount of utility also requires that the predetermined goals of an individual’s rational and self-interested choice will require the lowest amount of cost relative to the desired gain.

The term rational applied here means strictly rational to one’s well-being and does not intend to imply that the choice made is rational in the sense of a moral or socially acceptable standard. Many economists also apply the term rational only to decisions made that will knowingly produce higher utility in the short-run and not knowingly produce disutility in the long-run. Only very strict interpretations of the term perceive individuals to know exactly what will be the most rational decision in the long-run.

History of Homo Economicus:

The term Homo Economicus was “used for the first time in the late nineteenth century by critics of John Stuart Mill’s work on political economy.”[1] Mill’s nineteenth century work describes the “Economic Man” without actually referring to the term:

"Political economy does not treat the whole of man’s nature as modified by the social state, nor of the whole conduct of man in society. It is concerned with him solely as a being who desires to possess wealth, and who is capable of judging the comparative efficacy of means for obtaining that end."[2]

Many argue, however, that the “Economic Man” as it is understood today actually came from the writing of Adam Smith in the eighteenth century:

"It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest."[3]

Although rational self-interest has always been applied to accumulation of wealth and personal gain, Homo Economicus has evolved from its original meaning. In recent times Homo Economicus “emerged as a human with an insatiable appetite for financial gain and wealth accumulation” with “GDP per capita becoming the ultimate measure of the quality of life for humans.”[4]

Inherent Criticisms:

Although widely accepted and applied to nearly all economic decisions in past decades, many economists of the 21st century are not nearly as likely to accept the concept of Homo Economicus. Economists such as Veblen and Keynes have criticized this concept for having too much knowledge and information about the macroeconomic world and impacts of the future. They “stress uncertainty and bounded rationality in the making of economic decisions, rather than relying on the rational man who is fully informed of all circumstances.”[1]

Another criticism is that even if perfect information was possible, human beings are known to act irrationally. In an economically rational world, investors would never risk losing money for a chance to gain a large sum of money if there was a guarantee that a small portion could be gained otherwise. In this case the economic man would simply take the guaranteed smaller sum.

The final powerful criticism of the practicality of Homo Economicus is that every individual actor has individual goals and motives that will influence his/her decision making. Many humans do act with others in mind, which goes against the theory, and will make economic decisions that may help out a friend or family member while perhaps risking an economic loss.

This research has lead Professor of Economics in Edinburgh Gavin Kennedy to proclaim:

“Homo economicus cannot be improved; it is just plain wrong as it pretends to model behaviour in an economy representative of the real world. It isn't. It models behaviour in an imaginary economy that does not exist.”[5]

With Homo Economicus being strongly doubted by many respected economists in recent years, there must be another method of studying why and how humans make their economic decisions.

What is Neuroeconomics?

“Instead of hypothesising about Homo economicus, they could base their research on what actually goes on inside the head of Homo sapiens.”[6]

Neuroeconomics is an “emerging transdisciplinary field that uses neuroscientific measurement techniques to identify the neural substrates associated with economic decisions.”[7] It is also a “research field incorporating neuroscience, economics, and psychology aimed at developing an understanding of how we make choices. It looks at the brain when we evaluate decisions, categorize risks and rewards, and when we interact with others.”[8] As a small branch of behavioral economics, neuroeconomics also uses brain scans such as PET scans and fMRI scans to detail brain activity. In these active MRIs, “participants are expected to answer economic questions while blood flows in the brain are scrutinized to see where activity is going on while decisions are made.”[6]

An example of Neuroeconomic research would be analyzing how a person decides which of two job offers to take. The person could take job offer A which will pay them $100,000 per year with very little chance to move up. Job offer B starts the person at $50,000 per year but there is substantial room to move up the job ladder if that person is successful; and the risk of being fired if they are not. Predictions can be made by the type of person who is offered the jobs, a risk taker or risk-averse person, but without a detailed scan concluding what the person will pick is extremely difficult. Although neuroeconomics is a slowly growing discipline, “advances in genetics and brain imaging have made it possible to observe more detailed processes in the brain better than ever before”[9] meaning that scientific neurally-detailed descriptions will soon become available.

Prominent Supporters:

Ernst Fehr

Herbert Gintis

Joseph LeDoux

Colin Camerer

Paul Zak

Sam Bowles

Sources:

[1] "Homo Economicus." Wikipedia. 20 Apr. 2009 <http://en.wikipedia.org/wiki/Homo_economicus>.

[2] Mill, John Stuart. "On the Definition of Political Economy, and on the Method of Investigation Proper to It," London and Westminster Review, October 1836. Essays on Some Unsettled Questions of Political Economy, 2nd ed. London: Longmans, Green, Reader & Dyer, 1874.

[3] Smith, Adam. “On the Division of Labour,” The Wealth of Nations, Books I-III. New York: Penguin Classics, 1986, 119.

[4] Gutierrez, Luis T., ed. "Human Dimension of Sustainable Development." Solidarity, Sustainability, and Non-Violence 4 (Mar. 2008).

[5] Kennedy, Gavin. Adam Smith. 22 Apr. 2009 <http://www.adamsmithslostlegacy.com>.

[6] "Do Economists Need Brains." The Economist 24 July 2008.

[7] Zak, Paul. "Neuroeconomics." The Royal Society (2004). 26 Nov. 2004. 17 Apr. 2009 <www.neuroeconomicstudies.org>.

[8] "The Society for Neuroeconomics." 27 Oct. 2005. Decision Science News. 22 Apr. 2009 <http://www.decisionsciencenews.com>.

[9] Camerer, Colin. "What is Neuroeconomics." California Institute of Technology. 21 Apr. 2009 <www.hss.caltech.edu/~camerer>.