Neuroeconomic Theory: Using Neuroscience to Understand the Bounds of Rationality

Theoretical REsearch in Neuroeconomic Decision-making Neuroeconomic Theory: Using Neuroscience to Understand the Bounds of Rationality Workshop – Biology and Economics (June 2011) Juan D. CarrilloUSC and CEPR

Neuroeconomic Theory Use evidence from neuroscience, neurobiology and neuroeconomics to revisit economic theories of decision-making Neuroscience evidence Limited interactions Existence of multiple systems in the brain Hierarchical structure Conflicting objectives … in flow of information Physiological constraints in processing capacity in memory …

Neuroeconomic Theory Revisit theories of decision-making no! Behavioral anomaly (“output”) Model of bounded rationality Brain architecture (“input”) yes • Processes taken for granted • (learning, information processing, etc.) Obtain “micro-microfoundations” • Characteristics traditionally exogenous • (discounting, risk-aversion, etc.)

Neuroeconomic Theory Organizations (pre-theory of the firm): f(k,l) Individual (pre-neuroeconomics): U(x,y) The brain is, so it should be modeled as, a multi-system organization

Model 1 (Brocas-Carrillo, AER 2008) • Intertemporal choice: 2 dates of consumption / labor • Utility “Principal” Pcortical system “Agent 1” A1 limbic system at date 1 “Agent 2” A2 limbic system at date 2 where θt is valuation at date t known only by At Intertemporal budget constraint: Atchooses his preferred pair … but P can restrain At’s choices, and we allow any rule / restriction

Model 1 (Brocas-Carrillo, AER 2008) Optimal consumption / labor rule (under asymmetric information): • Consumption at t depends on labor at t  current consumption tracks earned income • Informational conflict  endogenous emergence of time-preference rate • Positive ( (t+1) < (t) ) • Decreasing impatience ( (t+1) / (t) >(t) / (t-1) )

Model 2 (Brocas-Carrillo, AER 2008) • “Incentive salience” • One system mediates motivation to seek pleasure (wanting) • A different system mediates the feeling of pleasure (liking) Principal P Agent A •  > 1: A is tempted to over-consume (biased motivation) • P does not integrate A’s “salience” • P can impose any choice but θ is known only by A

Model 2 (Brocas-Carrillo, AER 2008) Optimal consumption rule (under asymmetric information): • P imposes only two constraints: consumption cap and budget balance • Achooses: • If θ < θ* : unconstrained optimal pair given his bias • If θ > θ* : same pair as an agent with valuation θ*  Rationale for simple rule: “do what you want but don’t abuse”  Stronger bias ()  tighter control ()

Model 3 (Alonso-Brocas-Carrillo, mimeo 2011) • CES allocates resources {x0, x1, x2} to A0, A1, A2 CEScentral executive system x0 x1 x2 A2 (spelling) A0 (lifting) A1 (rotation) Motor function 0“public info.” Cognitive functions 1 and 2 1and 2“private info.”

Model 3 (Alonso-Brocas-Carrillo, mimeo 2011) Optimal allocation to each system (under asymmetric information): • P imposes a cap to Ai (weakly) decreasing in j  Each system has minimum guaranteed resources  Better performance in easy tasks than in difficult tasks • Task inertia: conditional on present needs, allocation of Ai is higher if past needs were high.

Conclusions • The brain is a multi-system organization. • It is time to open the black box of decision-making processes: • Neuroscience brings the knowledge • Microeconomics brings the tools • Bounded rationality models based not on inspiration but on physiological constraints  derive behaviors from brain limitations

Neuroeconomic Theory: Using Neuroscience to Understand the Bounds of Rationality