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Neuroeconomics

Raj Nallari's picture

Introduction 

In classical economic theory, the consumer is assumed to be a rational decision maker who makes choices to maximize his utility given his budget constraints. The consumer is also assumed to make intertemporal choices about savings, education, work effort, career and health care, after weighing in the opportunity cost of his funds. The classical economic model is modeled on the basic economic principles that consumers are rational and that they are equipped with immutable logic to further their best interests. As a natural corollary, classical economic thought would predict that consumers would save for their retirement, take only loans that they can afford to repay regularly over their lifetime, and consume the quantity of goods and services that balances their intertemporal budget constraints.  

What then explains the apparently illogical behavior of consumers tossing coins into a slot machine without having any expectations of winning, or splurging their savings on holidays they can ill afford rather than saving for retirement, or even, successively refinancing their homes and indulging in conspicuous consumption while knowing fully well that either the unpredictable housing or labor markets makes repayment of debts very difficult? These decisions of consumers are not rational purchasing decisions and contrary to classical economic thought. This has led to an emerging field in economic thought and research, called neuroeconomics, that suggests that the interplay between the various centers of the brain play a part in the financial decisions that people make. 

Neuroeconomics is an emerging transdisciplinary field, primarily neuroscience, psychology and economics to study how we make choices. It looks at the role of the brain when we evaluate decisions and how the brain categorizes risks and rewards. “Economics” in the field if neuroeconomics is to be interpreted in the broadest sense of any decision making process that involves making a choice from available alternatives.

Read my full draft paper on Neuroeconomics. Comments are welcome, as usual.

Comments

Submitted by Trevor Stack on
Great Paper! I'm glad it addressed government paternalism. Although the section is fairly general, I'm sure that one of the primary ways that neuroeconomics can influence policy is by offering not only data on, but neurological support for, on some of those "irrational" things that we do (especially around addiction). I wonder how these data would have been used in the days of US prohibition...

Submitted by Blu Ray on
The theory of being rational has been long discussed. It's also a big topic in the financial markets and known as behavioral finance. It is fact and can be seen on the financial desasters on Wall Street, that the market participiants are human beings which are irrational. I would say the stock market is a mirror of the real economy. Good paper by the way.

Submitted by quietlovely on
I think Neuroeconomics is the most valuable branch of science. Really, we make our choises depending on our own psychology and not rationalism. Even today's Financial Crisis is the result of our emotions and nothing else!

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