This is a summary for the minor “Neuroeconomics: How the brain decides”. At the Rotterdam School of Management, these are my own notes of the lectures and literature, sorted by lecture. I have successfully obtained the minor myself and this summary can easily help you in studying both the parti...
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Samenvatting Cognitieve neurowetenschap voor Geesteswetenschappers 2023/2024
Samenvatting 0HV40 Brain, Body And Behaviour - The Student's Guide to Cognitive Neuroscience
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Minor Neuro Economics: How the brain decides.
Lecture 1 Monday September 3
Introduction
What is neuro economics?
- The study of human decision making
- Explaining observed behaviour (actual choices people make)
• Qualified in psychological theory
• Quantified in tractable economic models
• Tested against biological brain evidence
- Unified discipline in which psychology, economics and neuroscience converge
Neuro economics → one language between economics, psychology & neuroscience.
They all study the same things and fields but talk about different things e.g. utility
(economics) vs attitude (psychology) vs stratum (neuroscience).
What do we do?
- Example Miljoenen jacht/deal or no deal. → research on; do previous gain and losses
affect our risk attitude on the next decision?
- Example Escher → Also research on; why is it so difficult to be different?
- Example Nespresso/George Clooney → How do status and fame affect choices and
differences?
- Example testosterone effect on risky choices → How do hormones affect our
choices?
- Example movie likes, how many would go to the cinema? → Can we predict choices
on neuroeconomics? (Forecasting)
,Lecture 2 Thursday September 6
‘Decision making and behavioral economics’
“How people take risks”
VB: How much are you willing to pay?
1. 0 or 10 → head or tail, then you will pay a maximum of 5 euros to play because =
expected value
2. Going on or doubling with hear or tail = St. Petersburg paradox (1713) because
expected value is infinite.
Bernoulli said but they don’t expect more so they don’t want to pay more.
This leads to:
Because when you’re poorer, you want to win more and risk more for 1 euro so you
will go on and pay more for the infinite game. More risk seeking then.
- Risk aversion
Risk averse = you want to pay less for the game then the expected value
Risk preferring/seeking = you want to pay more for the game then the expected
value
Risk neutral = you are indifferent
➔ Most people are risk averse (generally) so this explains ‘equity premium’.
VB: Ellsberg’s experiment
A: 50/50 red/blue balls B: Unknown divided
➔ People chose A because they think they will always be in unfavor when it’s
unknown divided. They will always choose for certainty when possible in all ways
because people dislike ambiguity.
, - Ambiguity aversion:
Risk: Probability distribution is precisely known
Uncertainty/ambiguity: distribution is not precisely known
VB: People prefer to bet on soccer matches then on head/tail even though it’s
unknown but they think they know.
- Expected Utility Theory (EUT)
By Daniel Bernoulli
Describes how people should make decisions by means of rational computations
based on objective outcomes and probabilities, without cognitive limitations and
emotions. Also applied descriptively to measure risk aversion.
Von Neumann – Morgenstern axioms:
- Completeness
- Transitivity
- Continuity
- Independence → Most important!!
Other commonly made assumptions:
- Invariance
- Monotonicity
- Asset integration
- Risk aversion
Asset integration = final wealth states matter, not just the wins.
Expected utility = Under a set of assumptions, preferences are presented by a formula.
VB: Evaluation of gambling opportunity
Expected Utility Theory Failing violations: Independence axiom
Common consequence effect
VB: Multi-millionaire or nothing. People chose A&D but this is not the same as the EUT.
VB: Asian decease; what do you choose?
A: 200 saved
B: 1/3 chance 600 saved, 2/3 no will be saved
➔ People choose A but when it is asked the other way around so 400 killed or 1/3 all
saved. People choose B so they are more risk seeking when it’s about dying.
VB: Fly in men’s toilet leads to 80% less spillage. Why?
VB: Rabians critique; Johnny is risk averse always turns down games even when he can win a
lot, but in real life if you can win 250 million or lose 100 euro everyone will play the game so
the theory is not always right.
Examples: Travel insurance, mobile phone insurance, low deductibles (with health
insurance) → They all mean you’re risk averse for small payments.
, Prospect theory (PT)
Amon Tversky & Daniel Rahneman (1979 & 1992)
= The answer to observations of preferences, incompatible with EUT.
→ Descriptive model, with key elements:
- Framing terms of gains & losses
- Loss aversion
- Convex value function for losses
- Probability weighting
2 Phases of PT → Choice Theory
Gain/loss framing is the most important difference between EUT & PT!!
VB: Chess board black/white differences
- Sensory:
Brightness
Loudness
Temperature
- Non-sensory
Health
Salary
Wealth
Course grades
→ 1st step: Reference point changes a lot; Influences on gains and losses!
Factors that determine the reference point:
- Status quo
- Expectations
- Social norms
- Goals
→ 2nd step: Evaluation;
Value function for gains
VB: Diminishing sensitivity with the same expected value, preference for the less risky
choice. Net zoals keuken van 1000 euro verschil of ergens anders 1000 euro aan uitgeven.
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