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Abstract:
We review recent developments in neuroeconomics and their implications for economics. The paper consists of six sections. Following the Introduction, the second section enumerates the different research methods that neuroscientists use evaluates their strengths and limitations for analyzing economic phenomena. The third section provides a review of basic findings in neuroscience that we deemed especially relevant to economics, and proposes a two-dimensional dichotomization of neural processes between automatic and controlled processes on the one hand, and cognitive and affective processes on the other. Section four reviews general implications of neuroscience for economics. Research in neuroscience, for example, raises questions about the usefulness of many economic constructs, such as 'time preference' and 'risk preference'. It also suggests that, contrary to the assumption that humans are likely to possess domain-specific intelligence - to be brilliant when it comes to problems that the brain is well evolved for performing and flat-footed for problems that lie outside of the brains existing specialized functions. Section 5 provides more detailed discussions of four specific applications: intertemporal choice, decision making under risk and uncertainty, game theory, and labor-market discrimination. Section 6 concludes by proposing a distinction between two general approaches in applying neuroscience to economics which we term 'incremental' and 'radical'. The former draws on neuroscience findings to refine existing economic models, while the latter poses more basic challenges to the standard economic understanding of human behavior.

Neuroeconomics, neuroscience

Abstract:
Consumers often behave differently than they would ideally like to behave. We propose that an anticipatory pain of paying drives tightwads to spend less than they would ideally like to spend. Spendthrifts, by contrast, experience too little pain of paying and typically spend more than they would ideally like to spend. This article introduces and validates the Tightwad-Spendthrift scale, a measure of individual differences in the pain of paying. Spending differences between tightwads and spendthrifts are greatest in situations that amplify the pain of paying and smallest in situations that diminish the pain of paying.

Consumer Decision Making, Individual Differences, Behavioral Economics, Experimental Economics

Abstract:
Behavioral economics is the effort to increase the explanatory and predictive power of economic theory by providing it with more psychologically plausible foundations. Behavioral economics, which recently emerged as a bona fide subdiscipline of economics, raises a number of questions of a philosophical, methodological, and historical nature. This chapter offers a survey of behavioral economics, including its historical origins, results, and methods; its relationship to neighboring fields; and its philosophical and methodological underpinnings. Our central thesis is that the development of behavioral economics in important respects parallels the development of cognitive science. Both fields are based on a repudiation of the positivist methodological strictures that were in place at their founding and a belief in the legitimacy of making reference to unobservable entities such as beliefs, emotions, and heuristics. And both fields adopt an interdisciplinary approach, admitting evidence of many kinds and using a variety of methods to generate such evidence. Moreover, there are in fact more direct links between the two fields. The single most important source of inspiration for behavioral economists has been behavioral decision research, which can in turn be seen as an integration of ideas from cognitive science and economics. Exploring the parallels between the two endeavors, we attempt to show, can shed light on the historical origins of, and the specific form taken by, behavioral economics.

Behavioral Economics, Cognitive Science, History, Philosophy, Methodology

Abstract:
This article, prepared for the forthcoming third edition of The Handbook of Emotion, surveys behavioral economic and neuroeconomic research on the influence of expected and immediate emotions on decision making under risk, intertemporal choice, and social preferences.

Emotion, Behavioral Economics

Abstract:
The economic conception of human behavior assumes that a person has a single set of well-defined goals, and that the person's behavior is chosen to best achieve those goals. We develop a model in which a person's behavior is the outcome of an interaction between two systems: a deliberative system that assesses options with a broad, goal-based perspective, and an affective system that encompasses emotions and motivational drives. Our model provides a framework for understanding many departures from full rationality discussed in the behavioral-economics literature, and captures the familiar feeling of being "of two minds." By focusing on factors that moderate the relative influence of the two systems, our model generates a variety of novel testable predictions.

Abstract:
Virtually all current theories of choice under risk or uncertainty are cognitive and consequentialist. They assume that people assess the desirability and likelihood of possible outcomes of choice alternatives and integrate this information through some type of expectation-based calculus to arrive at decision. The authors propose an alternative theoretical perspective, the risk-as-feelings hypothesis, that highlights the role of affect experienced at the moment of decision making. Drawing on research from clinical, physiological, and other subfield of psychology, they show that emotional reactions to risky situations often drive behavior. The risk-as-feelings hypothesis is shown to explain a wide range of phenomena that have resisted interpretation in cognitive-consequentialist terms.

choice under risk, affect, risk-as-feelings, risk preference, risk attitude

Abstract:
Standard economic models assume that the weight given to information from different sources depends exclusively on its diagnosticity. In this paper we study whether the same piece of information is weighted more heavily simply because it arose from direct experience rather than from observation. We investigate this possibility by conducting repeated game experiments in which groups of players are randomly rematched on every round and receive feedback about the actions and outcomes of all players. We find that participants' actions are influenced more strongly by the behavior of players they directly interact with than by those they only observe.

Games, behavioral economics, psychology, experimental economics, learning

Abstract:
We review methodological issues that arise in designing, implementing and evaluating the efficacy of 'light' paternalistic policies. In contrast to traditional 'heavy-handed' approaches to paternalism, light paternalistic policies aim to enhance individual choice without restricting it. Although light paternalism is a 'growth industry' in economics, a number of methodological issues that it raises have not been adequately addressed. The first issue is how a particular pattern of behavior should be judged as a mistake, and, relatedly, how the success of paternalistic policies designed to rectify such mistakes should be evaluated - i.e., the welfare criterion that should be used to judge light paternalistic policies. Second, paternalism, and especially light paternalism, introduces new motives for attempting to understand the psychological processes underlying economic behavior. An enhanced understanding of process can help to explain why people make mistakes in the first place, and, more importantly, provide insights into what types of policies are likely to be effective in correcting the mistakes. Third, there is an acute need for testing different possible policies before implementing them on a large scale, which we argue is best done in the field rather than the lab. Fourth, in addition to methodological issues, there are pragmatic issues concerning who will implement light paternalistic policies, especially when they involve positive expenditures. We discuss how economic interests can be rechanneled to support endeavors consistent with light paternalism.

Behavioral economics, asymmetric paternalism, libertarian paternalism, behavioral public policy, welfare criteria

Abstract:
In three experiments, subjects stated their willingness to accept pain ? from listening to annoying sounds ? in exchange for payment (WTA). Subjects were presented with annoying sounds of different durations, indicated their WTA, and received the sounds and payment that resulted from their prices. At the onset of each experiment subject were asked to listen to the sound. Since the sound was very simple, from that point subjects had full information about the hedonic experience. After the initial exposure subjects were asked to state whether, hypothetically, they would be willing to listen to the noise for 30 seconds for either a large or small payment. Subsequently, their actual WTA was elicited to listen to the noise for different intervals (10, 30 and 60 seconds in the first experiment). WTA values exhibited a pattern that we label "coherent arbitrariness." Suggestive of coherence, prices were systematically related to noise duration. But, suggestive of arbitrariness, prices were powerfully influenced by the arbitrary high/low anchor accompanying the hypothetical question. The first study documented the effect at the individual level, the second in experimental markets, and the third examined more deeply the effect of the initial anchor.

Abstract:
People underappreciate how their own behavior and exogenous factors affect their future utility, and thus exaggerate the degree to which their future preferences resemble their current preferences. We present evidence which demonstrates the prevalence of such projection bias, and develop a formal model that draws out both descriptive and welfare implications of the bias. The model helps interpret established behavioral anomalies such as the endowment effect, and helps to explain commonly observed suboptimal patterns of behavior such as addiction and excessive pursuit of a high material standard of living. The model also suggests potentially welfare-improving policies, such as mandatory "cooling-off periods" for certain types of consumer decisions.

Addiction, Consumption, Cooling Off, Misprediction, Projection Bias, Reference Dependence

Abstract:
We develop a model of selective attention to information and apply it to investors' decisions about whether to obtain information about the value of their portfolio. In our model investors receive information about the aggregate level of the market and then decide whether to look up the value of their personal portfolio. Doing so not only provides additional information, but also increases the psychological impact of information on utility - an impact effect - and increases the speed of a utility reference point adjustment - a reference point updating effect. The main prediction of the model is that investors will check the value of their portfolios more frequently in rising markets but will "put their heads in the sand" when markets are flat or falling. We test and find support for this prediction with three Scandinavian data sets.

investor behavior, selective exposure, attention

Abstract:
Conflicts of interest can lead experts to give biased and corrupt advice. Although disclosure is often proposed as a potential solution to these problems, we show that it can have perverse effects. First, people generally do not discount advice from biased advisors as much as they should, even when advisors' conflicts of interest are honestly disclosed. Second, disclosure can increase the bias in advice because it leads advisors to feel morally licensed and strategically encouraged to exaggerate their advice even further. This means that while disclosure may [insufficiently] warn an audience to discount an expert-opinion, disclosure might also lead the expert to alter the opinion offered and alter it in such a way as to overcompensate for any discounting that might occur. As a result, disclosure may fail to solve the problems created by conflicts of interest and it may sometimes even make matters worse.

This paper is part of a larger body of research which examines how trying to regulate ethical behavior (and/or trying to protect consumers) can potentially backfire.

conflicts of interest, disclosure, advice, advising, moral licensing, altruism, consumer protection, regulation, ethics

Abstract:
This paper challenges the common assumption that economic agents know their tastes. After reviewing previous research showing that valuation of ordinary products and experiences can be manipulated by non-normative cues, we present three studies showing that in some cases people do not even have a pre-existing sense of whether an experience is good or bad - even when they have experienced a sample of it.

Preferences, preference uncertainty, coherent arbitrariness

Abstract:
Prior research has established that people's own physical attractiveness affects their selection of romantic partners. The current work provides further support for this effect and also examines a different yet related question: when less attractive people accept less attractive dates, do they persuade themselves that those they choose to date are more physically attractive than others perceive them to be? Our analysis of data from the popular website HOTorNOT.com suggests that this is not the case: less attractive people do not delude themselves into thinking that their dates are more physically attractive than others perceive them to be.

Dating Preferences, Hedonic Adaptation, Prospect Theory, Attractiveness

Abstract:
Contrary to the assumption in much social science research that people have stable, coherent, preferences with respect to privacy, we find that concern about privacy, measured by divulgence of private information, is highly sensitive to contextual factors. We report results from 3 experiments, one of which was designed to elevate privacy concerns (paradoxically through assurances) and two of which were designed to suppress privacy concerns. This research raises serious questions about whether individuals will be able to navigate the increasingly complex issues of privacy in a self-interested fashion.

Privacy, Behavioral Economics, Laboratory Experiment, Consumer Research, Disclosure

Abstract:
We draw out implications of the identifiable victim effect - the greater sympathy shown toward identifiable than statistical victims - for public finance. We first review research showing (1) that people respond more strongly to identifiable than statistical victims even when identification provides absolutely no information about the victims, (2) that the identifiable victim effect is a special case of a more general tendency to react more strongly to identifiable others whether they evoke sympathy or other emotions, and (3) that identifiability influences behavior via the emotional reactions it evokes. Next, we discuss the normative status of the effect, noting that, contrary to the usual assumption that people overreact to identifiable victims, identifiability can shift people's responses in a normatively desirable direction if people are otherwise insufficiently sympathetic toward statistical victims. Finally, we examine implications of the identifiable victim effect for public finance. We show that the identifiable victim effect can influence the popularity of different policies, for example, naturally favoring hidden taxes over those whose incidence is more easily assessed, since a hidden tax has no identifiable victims. Identifiable other effects also influence public discourse, with much of the debate about government spending and taxation being driven by vivid exemplars - iconic victims and perpetrators - rather than any rational calculation of costs and benefits.

identifiable victim effect, tax policy, public finance, behavioral economics

Abstract:
Arguably, all judgments and decisions are made in 1 (or some combination) of 2 basic evaluation modes-joint evaluation mode (JE), in which multiple options are presented simultaneously and evaluated comparatively, or separate evaluation mode (SE), in which options are presented in isolation and evaluated separately. This article reviews recent literature showing that people evaluated options differently and exhibit reversals of preferences for options between JE and SE. The authors propose an explanation for the JE/SE reversal based on a principle called the evaluability hypothesis. The hypothesis posits that it is more diffecult to evaluate the desirability of values on some attributes than on others and that, compared with easy-to-evaluate attributes, difficult-to-evaluate attributes have a greater impact in JE than in SE.

evaluability, joint evaluation, separate evaluation, preference reversal, utility function

Abstract:
In a field experiment, we measure the impact of payment with credit card as compared with cash on insurance company employees' spending on lunch in a cafeteria. We exogenously changed some diners' payment medium from cash to a credit card by giving them an incentive to pay with a credit card. Surprisingly, we find that credit cards do not increase spending. However, the use of credit cards has a differential impact on spending for revolvers and convenience users: Revolvers spend less when induced to spend with a credit card, whereas convenience users display the opposite pattern.

Credit cards, spending, field experiments

Abstract:
People tend to value objects more highly simply because they own them. Prior research indicates that people underestimate the impact of this endowment effect on both their own and other people's preferences. We show that underestimation of the endowment effect can lead to suboptimal behavior in settings with economic consequences. Subjects acting as a "buyer's agent" made suboptimally low offers for an owner's commodity. Although buyer's agents learned to make increasingly optimal (i.e., higher) offers over repeated interactions with an initial commodity, this learning did not generalize to a new commodity.

Behavioral economics, endowment effect, experimental economics

Abstract:
Historical perspectives, as well as recent work in psychology, converge on the conclusion that human behavior is the product of two or more qualitatively different neural processes that operate according to different principles and often clash with one another. We describe a specific 'dual process' perspective that distinguishes between deliberative and emote control of behavior. We use this framework to shed light on a wide range of legal issues involving foreign policy, terrorism, and international law that are difficult to make sense of in terms of the traditional rational choice perspective. We argue that in these areas, the powerful influence of emotions not only on the general public, but on politicians and judicial decision makers, leads to a substitution of symbol for substance that can be seen at two different levels: (1) in the types of situations and stimuli that drive people to action (namely vivid symbols rather than rational arguments), and (2) in the types of actions that people take - specifically symbolic actions that are superficially satisfying as opposed to more substantive actions that are less immediately satisfying but actually more likely to produce desired long-term results.

emotion, law and economics, foreign policy, international law

Abstract:
Curiosity has been described as the "wick in the candle of learning" but its underlying mechanisms are not well-understood. We scanned subjects with fMRI while they read trivia questions. The level of curiosity when reading questions is correlated with activity in caudate regions previously suggested to be involved in anticipated reward or encoding prediction error. This finding led to a behavioral study showing that subjects spend more scarce resources (either limited tokens, or waiting time) to find out answers when they are more curious. The fMRI also showed that curiosity increases activity in memory areas when subjects guess incorrectly, which suggests that curiosity may enhance memory for surprising new information. This prediction about memory enhancement is confirmed in a behavioral study- higher curiosity in the initial session is correlated with better recall of surprising answers 10 days later.

Neuroimaging, Memory, Learning, Brain

Abstract:
Comparisons with counterfactual outcomes can influence choices in sequential decisions. We examine the effect of anticipated regret, and social takeover - the knowledge that someone else might take one's place - on persistence on an investment task. Some participants received feedback about what would have happened if they had continued investing and others did not. Some knew that another person had the opportunity to pick up their investment where they left off and others did not. Data collected from 84 dyads showed effects of both experimental manipulations. Participants invest longer, on average, when another person could take over from their previous investments, and when feedback was provided. Both anticipated regret and social takeover appear to increase the tendency to stick with an investment.

Commitment, Decision making, Social Comparison, Regret, Counterfactual Comparisons

Abstract:
Since the advent of the discounted utility (DU) model economists have thought about intertemporal choice in very specific terms. DU assumes that people make explicit tradeoffs between costs and benefits occurring at different points in time. While this explicit tradeoff perspective is simple and tractable, and has stimulated productive research, it does not provide a very realistic representation of a wide range of the most important intertemporal tradeoffs that people face in daily life. If one considers the most important and commonly discussed examples of intertemporal choices, a striking pattern emerges: In almost all cases, early outcomes tend to be concrete (e.g., purchasing this latte), but later outcomes tend to be much less tangible (e.g., the unknown item that could have been purchased later with the money spent on the latte). We propose that people rely on anticipatory emotions as a proxy for intangible outcomes when tradeoffs are implicit. This paper reviews neuroeconomic evidence that has begun to elucidate the role of anticipatory emotions in decisions involving intangible outcomes. Although the most progress has been made in the domain of spending and saving, we discuss how the existing neuroeconomic research could be extended to other domains where tradeoffs are ill-defined.

Intertemporal Choice, Discounted Utility, Tradeoffs, Tangibility, Emotion

Abstract:
One of the mysteries of drug addiction is why people start to use drugs that are known to be addictive. Prior research has found that people generally under-predict the impact on their own future preferences of visceral states, such as hunger, thirst and fear that they are not currently experiencing. Based on this research, we hypothesized that people who are not currently craving a drug - even addicts who have experienced craving frequently in the past - will under-appreciate the impact of craving on their own future preferences. To test this prediction, we elicited the money value that addicts placed on an extra dose of the heroin substitute Buprenorphine, when they were either in a state of craving (right before receiving BUP) or in a drug-satiated state (right after receiving BUP). In the most important condition, the reward they ended up receiving - either money or BUP - would be delayed by 5 days. As would be predicted if addicts can't remember what craving is like when they aren't currently craving, addicts valued the extra dose of BUP to be received 5 days later more highly when they were craving than when they were satiated.

Addiction, utility elicitation, decision making

Abstract:
Principal-agent relationships are typically motivated by efficiency gains from comparative advantage. However, such delegation may also arise because it allows principals the pursuit of selfish outcomes while avoiding explicitly selfish behavior. We report laboratory experiments in which principals repeatedly either decide how much money to share with a recipient or select agents to make sharing decisions on their behalf. Across several treatments, recipients receive significantly less when agents make allocation decisions. This results from principals seeking those agents willing to reliably share the least. We observe instances in which sharing is almost entirely extinguished when decisions are made through agents.

fairness, principal-agent, experiments

Abstract:
The impact of gifts on deposit balances and customer sentiment was examined in a longitudinal field experiment conducted on depositors at a bank. Several factors were manipulated: gift type, the accompanying message, and the sequence of gift value, which was either increasing ($35 then $100 gift), decreasing ($100 then $35 gift), or a single gift. Gifts increased deposit balances, survey response rates, and measures of customer satisfaction, trust and loyalty compared to the no-gift control. Within gift conditions the sequence of gift value was the most important factor, with a highly detrimental effect of decreasing value on deposit balances. These results showed evidence of persistence in a long term follow-up analysis of deposit balances.

reciprocation, gift giving, sequence effects, preference patterns

Abstract:
Neuroeconomics uses knowledge about brain mechanisms to inform economic theory. It opens up the "black box" of the brain, much as organizational economics opened up the theory of the firm. Neuroscientists use many tools - including brain imaging, behavior of patients with brain damage, animal behavior and recording single neuron activity. The key insight for economics is that the brain is composed of multiple systems which interact. Controlled systems ("executive function") interrupt automatic ones. Brain evidence complicates standard assumptions about basic preference, to include homeostasis and other kinds of state-dependence, and shows emotional activation in ambiguous choice and strategic interaction.

Abstract:
Based on contrast effects studies from psychology, we predicted that movers arriving from more expensive cities would rent pricier apartments than those arriving from cheaper cities. We also predicted that as people stayed in their new city they would get used to the new prices and would readjust their housing expenditures countering the initial impact of previous prices. We found support for both predictions in a sample of 928 movers from the PSID. Alternative explanations based on unobserved wealth and taste, and on imperfect information are ruled out.

Abstract:
Workers in a wide variety of jobs are paid based on performance, which is commonly seen as enhancing effort and productivity relative to non-contingent pay schemes. However, psychological research suggests that excessive rewards can, in some cases, result in a decline in performance. To test whether very high monetary rewards can decrease performance, we conducted a set of experiments in the U.S. and in India in which subjects worked on different tasks and received performance-contingent payments that varied in amount from small to very large relative to their typical levels of pay. With some important exceptions, very high reward levels had a detrimental effect on performance.

Abstract:
Neuroeconomics has further bridged the once disparate fields of economics and psychology. Such convergence is almost exclusively attributable to changes within economics. Neuroeconomics has inspired more change within economics than within psychology because the most important findings in neuroeconomics have posed more of a challenge to the standard economic perspective. Neuroeconomics has primarily challenged the standard economic assumption that decision making is a unitary process - a simple matter of integrated and coherent utility maximization - suggesting instead that it is driven by the interaction between automatic and controlled processes. This article reviews neuroeconomic research in three domains of interest to both economists and psychologists: decision making under risk and uncertainty, intertemporal choice, and social decision making. In addition to reviewing new economic models inspired by this research, we also discuss how neuroeconomics may influence future work in psychology.

decision making, emotions, dual-process theories, neuroscience, behavioral economics

Abstract:
This paper examines the regulatory implications of behavioral economic insights. The central effect of behavioral economics in the legal literature to date has been to challenge the premise of formal economic theory that individuals understand their preferences and work to maximize these preferences. Behavioral economics has gathered increased attention in the economic analysis of law because of its demonstration that individual decisionmaking is prone to numerous biases and heuristics, and that as a result individuals may not act to realize their best interests. Part of the enthusiasm for behavioral economics in the legal literature has come from the apparent compatibility of the behavioral insights with proposals for paternalistic regulation. By pointing out some of the ways that human behavior falls short of perfect rationality, behavioral economics can potentially expand the scope of beneficial paternalistic policies that constrain individual choice. However, such policies should be implemented cautiously, given differences in opinion about what behaviors are irrational and concerns about costs imposed on people who are rational. In response to these concerns, we propose a principle for developing and evaluating regulatory policies that we term "asymmetric paternalism." Asymmetrically paternalistic regulations benefit those who would otherwise make poor decisions, but impose little or no costs on those who behave optimally. As such, they challenges both opponents and supporters of regulation by setting forth a disciplined set of criteria by which to judge the costs and benefits of regulatory proposals. The article explores the application of this principle to several specific sources of flawed decision making identified by behavioral economics in such diverse areas as retirement savings, consumer protection, and family law, and suggests examples of already existing regulations in these fields that seem to embody the principle of asymmetric paternalism.

behavioral economics, regulation, paternalism

Abstract:
Traditional economic and decision-making models allow for "free disposal" of information, meaning that more information will always make a decision maker (weakly) better off. This implies that those faced with decisions should always place non-negative value on information. Building on previous research on the "curse of knowledge," we explore situations where this might not be so. In three experiments, we document situations in which subjects place positive value on information, even when learning that information hurts their performance and earnings. In the first experiment, a significant number of subjects pay for information - the solution to a puzzle - that hurts their ability to predict how many others will solve the puzzle. In the second experiment, a majority of subjects choose to "hire" informed - rather than uninformed - agents, leading to lower earnings. The third experiment reveals that the phenomenon is not reduced with experience, but that also that there are individual differences in the degree to which subjects fall victim to the bias. We discuss implications of our results for the role of information and informed decision makers in real economic situations.

Curse of knowledge, information, biases and heuristics, experiments

Abstract:
It is widely believed that people are willing to expend greater resources to save the lives of identified victims than to save equal numbers of unidentified or statistical victims. There are many possible causes of this disparity which have not been enumerated previously or tested empirically. We discuss four possible causes of the "identifiable victim effect" and present the results of two studies which indicate that the most important cause of the disparity in treatment of identifiable and statistical lives is that, for identifiable victims, a high proportion of those at risk can be saved.

Abstract:
Previous experimental research conducted by the authors has found that self-serving biases are a major cause of negotiation impasses. This article reports experimental studies that test the ability to counteract the biased integration of information that can impede settlement. In this study, we show that a simple intervention can mitigate such biases and promote efficients settlement of disputes.