Experimental Economics and Neuroeconomics

An Illustration:Rules

Experimental Economic Key Terms• Risk Preferences

How are Experiments Used?Provide Observations (Data): Data can be used to test theories

Reduce Real World Confounds: A lab experiment can be designed to ensure more of the theory’s assumptions hold• The environment: An agent’s environment, even preferences can be

controlled.• Institutions: The impacts of differing institutions, or rules under which choice

behavior occurs, can be examined.

Characterize Learning: Because subjects to not always make the best choices because they do not fully understand, but repeated choices in a controlled environment allows learning to be characterized. Robustness Checks: Parameters of the model can be changed to see whether (and how) the results change (e.g. increase the stakes in a game).

How are Experiments Used?Find Anomalies: Identify when and why a theory does not hold

Provide Simplified Models: Real world processes are often so complex that we cannot fully understand how data is generated from them. How data is generated from an experiment can be controlled, implying they can be used to model real world processes that are more complex.

Distinguish heterogeneities: Results may differ by sex, age, and many other individual factors. Experimentation can refine a theory by indicating how it might apply differently to different types of people.

Measure Preferences: Risk preferences, social preferences, and time preferences may vary. Experiments can be used to obtain preference measures that vary across people.

Theoretical Issues Examined Using Experimental Economics

Preferences• Risk Preferences• Social Preferences• Time Preferences• Endogenous Preferences

Cognitive Capabilities• Degree of sophistication• Depth of thinking

Theoretical Issues Examined Using Experimental Economics

Solution Concepts• Maximization (To predict the choice from a set of alternatives)• Satisficing (To predict a choice from a set of alternatives)• Nash Equilibrium (To predict outcomes of strategic interaction)• Bayesian Updating (To predict how beliefs will be updated)• Common Knowledge (Transparency about what all know and

about how all think)• Competitive Equilibrium (To predict outcome of market

interactions)

Neuroeconomics Ideas• Neuroscience: Uses brain imaging to make inferences about how the

brain works• Deliberative processing; The heart of traditional economic theory.

The process of comparing alternatives and arriving at a choice.• Automatic processing: Not recognized by traditional economic

theory, but supported by neuroscience. • Emotional (Affective) processing: Not recognized by traditional

economic theory, but supported by neuroscience. • Parallelism: • Specialized system:• Categorization• Homeostasis: The brain monitors a reference point and acts to

return itself to the reference point.• Mentalizing:

Neuroeconomics Key Terms• Fear Learning:

Neuroeconomic Findings • The brain implements controlled processes and automatic process• The brain implements cognitive processes and emotional processes• Affect is Primary: Emotion plays a dominant role in behavior.• The cognitive and affective systems collaborate and compete with

each other• Emotion can be over-ridden by cognition• Passion can over-ride cognition• Emotion can assist cognition so reasoned action is taken

• The brain develops tailored systems so expertise is specific, not general.

• Wanting something may be different than liking something, so that people can want what they do not like.

• Processes and preferences can become so automatic that they are not cognitively accessible, meaning behaviors and preferences viewed as bad cognitively can nonetheless be adopted.

Neuroeconomic Findings • Hyperbolic discounting may occur because affect/emotion drives

us to be myopic, even though we know when we think cognitively that we should exhibit self control. Time inconsistency arises because hot processes evoke emotional behavior.

• Fear increases aversion to risk and ambiguity• Trusting and making a more fair allocation in an ultimatum

bargaining game each cause the brain to react, or homones. People may not understand their play is being influenced.

• The ability to backward induce is a special ability that can be learned.

Neuroscience Methods• Combine Brain Imaging and Experimentation• Study responses of people with normal brains relative to the

response of people with damaged brains• Single neuron measurement and electronic brain stimulation in

animals:

References