1. Armin Falk and Bernd Weber Universitt Bonn, SS 08 Neuroeconomics Part I: Introduction

2. Overview

• Introduction

• Methods

• • Neuroanatomy - macro- and microanatomy of the human brain

• • • Visit the Institute of Anatomy

• • Neurophysiology - how neurons communicate

• • Methods of cognitive neuroscience (EEG, fMRI, PET, MEG....)

• • • Visit Life&Brain - NeuroCognition Lab

• Important neuroeconomics papers (see below)

3. Papers (to be completed)

• The Neural Basis of Economic Decision-Making in the Ultimatum Game Alan G. Sanfey, James K. Rilling,Jessica A. Aronson, Leigh E. Nystrom, Jonathan D. Cohen, Science 13 June 2003, vol. 300. no. 5626, pp. 1755 - 1758

• Getting to Know You: Reputation and Trust in a Two-Person Economic Exchange, Brooks King-Casas, Damin Tomlin, Cedric Anen, Colin F. Camerer, Steven R. Quartz, P. Read Montague, Science, 2005, vol. 308, pp. 78-83.

• Neuroeconomics: How Neuroscience Can Inform Economics, Colin F. Camerer, George Loewenstein, Drazen Prelec, Journal of Economic Literature, 2005, vol. 43, 9-64.

• Neuroeconomics: Why economics needs brains, Colin F. Camerer, George Loewenstein, Drazen Prelec, Scandinavian Journal of Economics, 2004, vol. 106, no. 3, 555-79.

• Oxytocin increases Trust in Humans, Michael Kosfeld, Markus Heinrichs, Paul Zak, Urs Fischbacher and Ernst Fehr, Nature 435, 2 June 2005, 673-676.

• The Neural Basis of Altruistic Punishment, Dominique J.-F. de Quervain, Urs Fischbacher, Valerie Treyer, Melanie Schellhammer, Ulrich Schnyder, Alfred Buck, Ernst Fehr, Science 305, 27 August 2004, 1254-1258.

• Strategizing in the Brain, Colin F. Camerer, Science, 2003, vol. 300, pp. 1673-75.

• Social Comparison Affects Reward-Related Brain Activity in the Human Ventral Striatum, K. Fliessbach, B. Weber, P. Trautner, T. Dohmen, U. Sunde, C. E. Elger, A. Falk, Science, 2007, Vol. 318, Issue 5854, 1305 1308.

• Unfair pay and Stress, Falk, Menrath, Kupio and Siegrist, Discussion paper.

4. What is Neuroeconomics?

• General: Neuroeconomics combines methods from neuroscience and economics to better understand how the human brain generates decisions in social and economic contexts

• • Marriage of neuroscience methods with experimental economics methods

• Definition (Laibson): Neuroeconomics is the study of the biological microfoundations of economic cognition.

• • Biological microfoundations are neurochemical mechanisms, like brain systems, neurons, genes, heart rate, skin resistance, and neurotransmitters.

• • Economic cognition includes mental representations, emotions, expectations, learning, memory, preferences, decision-making, and behavior.

5. Neuroeconomists

• About 100-200 neuroscientists and economists are actively working in this new field.

• Its roughly an even mix.

• This is in contrast to behavioral economics, where its a one-sided game (mostly economists and very few psychologists).

6. Neuroeconomics & Behavioral Economics

• Behavioral economics developed alternative models of economic behavior.

• • Prospect theory, hyperbolic discounting, learning models.

• • Fairness and reciprocity models.

• These models are black box models. They aim to predict behavior better but there is no ambition to understand the minds internal processes that generate the behavior.

• Questions

• • Are components of behavioral models represented in brain structures?

• • Can insights into how the brain works improve economic modeling?

• • Can those insights discriminate between alternative models?

7. Why is Neuroeconomics so fascinating?

• Brain research has made great progress during the past decade, largely due to noninvasive techniques that allow observing the brain while it is active.

• Systematic study of the relation between behavior and brain processes in healthy human subjects is possible.

• Possible to provide brain evidence for standard economic theory, allows deeper understanding of (behavioral) economics results

• Provide genuinely new insight into the neurobiological determinants of human behavior

• • and this is genuinely interesting and exciting in itself

8. What is the goal of neuroeconomics? Analogy to organizational economics (Camerer EJ 2007)

• Until 1970s theory of the firm was a radically reduced form model of how capital and labor are combined to produce output. This model neglects

• • principal-agent relations

• • Gift exchange

• • Efficiency wages

• • Hierarchy and authority

• • Communication networks

• • Etc

• Nevertheless a useful simplification for deriving industry supply curves and doing macroeconomics

• but clearly inapproapriate for a host of interesting questions

9. Opening the black box of the firm Contract theory

10. Opening the black box of the human brain Neuroeconomics (See Camerer 2007)

11. Brain evidence provides a deeper understanding of behavioral economics results

• Are social preference phenomena better modelled as preferences or as bounded rationality?

• One possibility to answer this question is to examine whether the brains reward mechanisms are activated if people make other-regarding choices

• Example: ultimatum game

12. Neural Basis of Responder Behavior in the Ultimatum Game (A. G. Sanfey, J. K. Rilling, J. A. Aronson, L. E. Nystrom, J. D. Cohen, Science 13 March 03)

• Responders brain activations are measured by fMRI in a $10 UG.

• A responder faces each of three conditions ten times.

• • Offers from a (supposed) human partner

• • Random offers from a computer partner

• • Money offer (there is no proposer here)

• Research Questions: Which brain areas are more activated when subjects face

• • fair offers (3-5) relative to unfair offers (1-2).

• • the offer of a human proposer relative to a random computer offer.

• Method (very simplified):

• • Regression of activity in every voxel (i.e, 3D Pixel) in the brain on the treatment dummy (i.e., unfair offer dummy, human proposer dummy)

13. Details of the Experiment

14. Differences in brain activity between unfair and fair offers from a human proposer

• What you see: Image of voxelwise t-statistic (red) is overlaid on top of a structural brain image (gray).

Bilateral anterior insula and anterior cingulate cortex. dorsolateral prefrontal cortex. Dorsolateral prefrontal cortex.

15. Results

• Regions showing stronger activations if subjects face unfair human offers relative to fair human offers (the same regions also show more activation if the unfair human offer is compared to unfair random offers).

• • Bilateral anterior Insula, anterior cingulate Cortex

• • • Emotion-related region

• • • Insula also has been associated with negative emotions such as disgust and anger.

• Dorsolateral prefrontal Cortex (DLPFC)

• • Cognition-related region

• • Associated with control of execution of actions

• • Associated with achievement of goals.

• Unfair offers are more likely to be rejected if insula activation is stronger.

16. Insula activation is related to unpleasantness

• Higher for offer of unfair person.

• Higher for more unfair offers.

• Higher for people who reject. (unclear: Is activation the cause of rejection or a byproduct?)

17. General procedure

• Observe subjects brains when they are in a decision situation.

• Find the voxels which are particularly active in particular situations.

• • • For example: Unfair vs. fair offers by humans.

• Interpret the observed activations by relating the results to studies that observe activations in the same brain regions. (Should be done ex ante.)

• Relate the observed brain activation with behavior.

18. What does this procedure rely on?

• Brain regions are functionally specialized. At least, brain functions are not homogeneously distributed across the brain.

• Working parts of the brain show some kind of activity.

• This activity is measured with fMRI.

19.

• Neuroscience Methods

• Topics in Neuroeconomics

• • Preferences

• • Decision-making under risk and uncertainty

• • Game theory and social preferences

20. Revealed preferences

• Economists: early doubts about the rationality of choice (see quote)

• • But fear that unstable and unrational complex (emotions, instincts, impulses,) of influences underlying human choice cannot be measured directly

• Economic approach: revealed preference theory

• • Crucial assumption: unobserved utilities are revealed by observable choices

• Breakthroughs in neuroscience: feelings and thoughts can be measured directly

21. A Timeline of Neuroscience (Methods) Ward (2006)

• Phrenology (Gall, Spurtzheim)

• Nerve cell described (Purkinje 1837)

• Lesion patients (Broca 1861), functional localization

• Electric current in dog cortex causes movement (Fritsch, Hitzig 1870)

• EEG (Berger, 1929)

• Action potential (Hodgkin Huxley, 1938), single cell rec.

• CT (Hounsfield, 1973), MRI (Lauterbur,1973), imaging

• PET (Reivich et al., 1979), measure blood flow

• TMS (Barker et al.,1985), noninvasive stimulation

• fMRI (Ogawa et al., 1990), measure BOLD

1800 1820 1840 1860 1880 1900 1920 1940 1960 1980 2000

22. Research with human subjects

• Studying humans with lesions

• • Associated deficits provide information about the function of the lesioned brain area.

• Observing the brain

• • indirect measures (psychophysiological measurements as skin conductance, heart rate)

• • Brain Imaging (EEG, PET, fMRI)

• • Pupil dilation -> mental effort

• • Blood pressure, heart rate, skin conductance -> anxiety

• Stimulating the brain

• • Transcranial Magnetic Stimulation TMS

• • • Enables a controlled, spatially and temporally limited, stimulation or inhibition of brain areas.

• • Psychopharmacological interventions

• • • Manipulation of neurotransmitter systems or hormone systems.

23. Lesion studies

• Naturally occurring lesions

• • Accident, stroke, brain tumor.

• Allows to determine that a particular function is processed independently from other functions.

• Allows to determine causally that a particular region is critical for the performance of a particular task.

• Problem

• • It is often difficult to determine the affected brain region

24. Results gained with lesions

• Broca found an area that is critical for speech production.

• Humans with lesions of the amygdala lose affective (i.e. emotional) meaning.

• Hippocampus removal prevents experiences from being encoded in long-term memory.

25. Phineas Gage

• Explosion pushed iron up through the top of the scull.

• He survived.

• He was intellectually rather unaffected by the accident.

• He was unable to make reasonable decisions.

26. Electro-encephalogram (EEG)

• Measures electrical potentials at the scull, caused by neural activity.

• Very good temporal resolution but poor spatial resolution.

• Large number of repetitions of the same situation is necessary.

• Interior brain activity is not directly recorded

• Further limits:

• • Eye movement creates also electric activity.

• • In some regions neurons are not aligned and activity can cancel out.

• Not well suited for most economic experiments.

128 electrode array

27. Magnetoencephalograghy (MEG)

• Rather new method, based on measuring the magnetic field generated by neural activity.

• Advantages in comparison to EEG

• • Signal unaffected by skull.

• • Good spatial resolution (2-3 mm).

• Disadvantages in comparison to EEG

• • Cannot detect signals from deeper brain structures.

• • Expensive.

28. Positron Emission Tomography (PET)

• A radioactive substance is injected into the blood.

• This substance emits positrons.

• These positrons decay, together with electrons .

• PET detects the brain area where this decay occurs, i.e., it detects the areas into which the radiation went.

• Variants:

• • Glucose with radioactive fluorine.

• • Water with radioactive oxygen; measures blood volume.

• Better spatial but poorer temporal resolution than EEG

• Limited to short tasks

29. fMRI (Functional Magnetic Resonance Imaging)

• MRI is based on the principle that protons in a magnetic field align with the field. If the magnetic field is perturbed the direction of the protons is disturbed. When the protons are redirected in the magnetic field electromagnetic radiation is emitted and is detected by the scanner.

• fMRI uses the fact that hemoglobin (red blood cells) have different magnetic properties depending on whether there is little or much oxygen in the blood.

• Increased neuronal activity in the brain uses up oxygen such that initially the oxygen level in the activated area falls; later on the fall in oxygen is overcompensated for when oxygen-rich blood moves to the activated area.

• BOLD-Signal (blood oxygen level dependent signal).

30. Temporal resolution of fMRI

• Blood flow has a lagged response to neural activity. (Hemodynamic response function HRF)

• Does still allow relatively good temporal resolution because HRF is known.

• Shortest stimuli that have been detected with fMRI:

• • Blamire et al. (1992): 2 sec

• • Bandettini (1993): 0.5 sec

• • Savoy et al (1995): 34 msec

31. How is fMRI data analyzed (will be discussed later)

• Behavioral analysis

• Preprocessing

• • Motion correction

• • Normalizing

• • Smoothing

• Statistical maps

• • Individual analysis: Which voxels correlate with the treatment, corrected for the homodynamic response?

• • Group analysis: Which voxels do so for many people.

• • One has to take into account that multiple tests are conducted (corrected and uncorrected p-values).

• Time course in regions of interests (ROI-analysis).

32. Block design and event related design

• Block design

• • • A experimental condition A is repeated several times, then the condition B is repeated several times,

• Event related design

• • • The experimental conditions A and B are presented on randomized order.

• • • This is in particular the case, when the timing of experimental conditions is determined endogenously (free decision time).

• • • Neuroeconomic experiments are usually event related, because the stimulus should unpredictable.

33. Comparison of PET and fMRI

• Advantages of fMRI:

• • higher spatial resolution.

• • higher temporal resolution.

• • less invasive (no radioactivity).

• Advantages of PET:

• • Silent (auditory stimuli).

• • Less movement artifacts when subjects speak.

• • Sensitive to the whole brain. fMRI creates artifacts' in the neighborhood of cranial cavities (Schdelhhle) (forehead, ear).

• • Fewer repetitions necessary.

• PET almost dominated by fMRI. Latter two point are potentially relevant for economic experiments.

34. Transcranial Magnetic Stimulation (TMS)

• Allows virtual lesions

• Non-invasive procedure: debated

• A strong, magnetic impulse induces small currents (Strme) in the brain (cortex).

• These currents create neural activity.

• Repeated stimulation at the same position can increase or decrease how strongly neuron respond.

• Temporally and spatially limited inhibition or activation of the brain function.

35. Pharmacological Methods

• Placebo controlled administration of substances inform about the functioning of neurotransmitter or hormone systems.

• Neurotransmitter

• • • Dopamine, Serotonin, Noradrenalin

• Neurohormons

• • • Oxytocin

• Sexual hormons

• • • Testosterone, Estrogen

• Stress hormons

• • • Cortisol

36. Other methods

• Single Neuron Measurement

• • Implantation of electrodes into the brain

• • While fMRI measures cumulative activity of thousands of neurons, each electrode measures a single neurons activity

• • Very invasive, therefore used on humans only if neurosurgery inevitable due to epilepsy, and on animals

• Psychopathology

• • Various illnesses have been associated with specific brain areas, some illnesses progress along a localized path in the brain

• • Chronic mental illnesses (schizophrenia), degenerative diseases of the nervous system (PD), developmental disorders (autism)

• • Inferences can be made about the role of specific brain areas in brain functioning

37. Overview of neuroscientific methods

38. Animal research

• Many brain areas in humans and animals have similar structures.

• • Its possible to produce addicted rats. Addiction is created in that part of the brain which we share with other mammals.

• • Learning.

• • Decision taking in monkeys.

• Creating lesions and single cell recording (i.e. measuring the electrical potentials of single neurons) is possible in non-human primates but not in healthy humans.

39. Controlled lesions

• Allows to determine causally whether a particular brain region (or connection between regions) is essential for a particular function.

• Examples:

• • Experimental destruction of both amygdalas in an animal tames the animal, making it sexually inactive and indifferent to danger like snakes or other aggressive members of its own species.

• • Knocking out the gene that makes a key protein for amygdala function makes rats relatively fearless.

40. Topics in Neuroeconomics: Preferences The following is taken from the Camerer et al. paper Neuroeconomics: Why Economics Needs Brains (Camerer, Loewenstein, Prelec, 2004, Scandinavian Journal of Economics)

• Revealed preference approach cannot tell the whole story

• • Al and Naucia both refrain from buying peanuts at a certain price

• • Common disutility?

• • Al has a fatal allergy (inelastic demand) while Naucia once simply ate too many peanuts (would be willing to eat some again for a certain price)

• • • Biological state-dependence vs. rational choice

• • • There is no low enough price to induce Al buying peanuts

• Tradeoff between sleep utility and risk of plowing into a tree utility?

• • Dead sleeper with U(sleep)>U(plowing into tree)???

• • Choice as a result from interaction of multiple systems (automatic biological system, controlled cognitive system)

41. Preferences

• Preferences are state-dependent

• • Whether I like having icecreme depends on the season

• • Homeostasis (Gleichgewicht der Krperfunktion)

• Different types of utility

• • Kahnemann: remembered utility, anticipated utility, choice utility, experienced utility

• • Different types do not always coincide

• • in particular for rare but important decisions

• • • • Contradictory to standard analysis of welfare, which assumes that choices anticipate experience perfectly

• • • • Examples: compulsive shoppers (revealing choice utility) buy stuff they dont use (experience utility); children drug and addicts (craving/wanting; consumption/choosing; not pleasurable)

• • Presumption in neurosciences: different types of utility are produced in different brain regions

42. Preferences

• Utility of money

• Economics: People are expected to value money for what it can purchase -> indirect utility of income

• Neuroeconomic evidence suggests that money can be directly rewarding -> direct utility of income

• • Monetary rewards seem to activate the same brain region (dopaminergic neurons in the midbrain) that is active for a wide variety of rewarding experiences

• Possible explanation for why workaholics and very wealthy people keep working even though the marginal utility of goods purchased with their marginal income is very low

• Pain of paying..., credit cards or preference for fixed payment plans rather than marginal-use pricing

43. Flat rates

• Many studies show that consumers choose flat rates even though marginal use schemes would be optimal, i.e., cost less (telephone, fitness studio)

• Explanations

• • Risk aversion (knowing the cost vs. uncertain cost)

• • Mental accounting and neuro perspective (pain of paying), see, e.g., Prelec/Loewenstein (1998)

• • • • They ask Ss whether they enjoy using different products more when paying flat rates or marginal use schemes: 48 percent prefer flat rate, only 19 percent prefer marginal use scheme (fitness studio, phone, traffic etc.)

• • Laziness

• • Overestimation effect (wrong subjective prob. of using a particular good)

• • Commitment device

44. Preferences

• Source of income

• • Economics: utility of income is independent of its source

• Neuroeconomic evidence: earned money is more rewarding than unearned money

• • Greater activity in the striatum (midbrain region) for earned income (Zink et al 2004)

• Implications for welfare and tax policies?

• • Workfare vs. welfare

45. What is better: welfare or workfare? A little digression

• Workfare programs introduced in several countries

• Unlike regular public assistance, workfare requires recipients to spend time on mandatory activities such as community work

• Economic theory predicts that workfare increases the incentive for benefit recipients to seek regular employment, because the work requirement reduces the attractiveness of being on public assistance

• However, workfare is often claimed to be unfair

• Can Neuroeconomics provide additional support?

46. This study (Falk, Huffman and Mierendorff 2006)

• Study the incentive effects of workfare

• Assess potential political support/resistance with respect to workfare

• • Explore motives behind voting for/against workfare

47. 1. Incentive effects

• Real effort task

• • Task has no intrinsic value

• • Experiment captures essential tradeoff between effort cost and wage

• Elicit reservation wages

48. Count the number of zeros: How many of these would you do for X Euro? Sheet 1

49. Phases of the experiment

• Phase 1: try the task

• Phase 2: choice tables

• • Subjects fill in choice tables

• Phase 3: work/payment

• • Subjects are paid and leave the lab, if on welfare

• • Subjects work if employed or on workfare

• • • Paid and allowed to leave as soon as they are done

50. Example choice table welfare regular job o o 9 Euro, 10 sheets 4 Euro, 0 sheets o o 2 Euro, 10 sheets 4 Euro, 0 sheets o o 1 Euro, 10 sheets 4 Euro, 0 sheets I choose Option 2 I choose Option 1 Option 2 Option 1

51. Example choice table regular job workfare o o 9 Euro, 10 sheets 4 Euro, 9 sheets o o 2 Euro, 10 sheets 4 Euro, 9 sheets o o 1 Euro, 10 sheets 4 Euro, 9 sheets I choose Option 2 I choose Option 1 Option 2 Option 1

52. Work outcomes and payment

• Subjects know how outcomes are determined:

• • One row in one table is randomly selected

• • Subjects choice for that row is implemented

• • • e.g. 4 Euros and leave the lab immediately

• • • or, 6 Euros after completing 5 sheets

• • Incentive compatible

• • Payment conditional on completing required sheets; receive money and leave when finished

53. Results Incentive effects are significant 5 sheets (p