Making economic decisions as individuals and in groups
Our consortium asked me to prepare a review of what we have learned about how we assign values to objects, time and people. This review was to be useful in support of our ‘Valurama’ collaborative project. The purpose of the project was to build both measurement and intervention tools that can be useful in making valuation decisions that people could live with in the present as well as in their future. Since valuation is the basis of economic decisions which drives and important facet of our lives the project could have huge practical implications.
I started my background research by reading laboratory study reports of how very young children decide the value of 3 candies vs. a whole bag of goodies that they might receive a little later? I was not surprised to learn that little children have trouble delaying gratification and so 3 candies are worth much more than many candies later (or a bird in the hand is worth lots more in the bush). This and related studies by the psychologist Walter Mischel at Columbia University were conducted several decades ago and were followed up by a whole program of research building on implications of these early findings. For example, recent studies by Mischel and colleagues demonstrated that children who have trouble delaying gratification are more likely to continue to have trouble inhibiting impulses and are more likely to suffer mental health problems over the course of their lives. Mischel has also recently studied related research themes such as craving, will-power, self-regulation along with the regional brain activity when these psychological functions are engaged.
I realized that the study of valuation (in children and adults) is complex involving many lines of research and methods of approach. I was quickly overwhelmed and should have anticipated that would happen. I know that I said I would write a posting that would cover all of the major features of what we know about how we place value on the ‘objects of our desire’ now and in the future, on our actions, and on our time and efforts. I have concluded that I will need time to develop this material. As a start in this posting that I have identified as Part I, I thought I would highlight (outline) some of the subfields of science that are relevant to the study of valuation and then I would sample some of the major findings based on what we have learned to date.
The research strategies and methods that have been used are quite diverse and include: neurobiological tools (such as brain imaging methods like fMRI); experimental psychological model-driven techniques; comparisons of different populations of subjects such as adults vs. children and patient populations such as substance abusers compared to controls; economic statistical analysis and modeling methods (from the world of finance). Other specialized areas of research relevant for understanding valuation decisions include: craving (drugs, food, etc); will power and self-regulation; inhibition and planning functions (executive functions associated with frontal and prefrontal brain regions; hot vs. cool cognition (cognition with and without emotional activation), learning and development of decision-making skills, group vs. individual valuation functions.
How we place value on objects and activities has also spurred a new field of research, Neuroeconomics, that has generated sustained crosstalk and collaboration between psychologists, neuroscientists, economists, professionals from the world of finance and business and clinicians. With the use of brain imaging methods such as fMRI researchers can measure regional brain activity in subjects as they are making economic decisions while engaged in experimental psychological tasks such as gaming simulations. I thought I would mention one example of this type of research. Read Montague at Baylor College of Medicine has been able to track brain activity of subjects responding to a simulation of our recent destructive financial bubble(Montague, PR, King-Casas, B, Cohen, JD (2006) Imaging valuation models in human choice. Annual Review of Neuroscience 29:417-448). Measures of brain activity were tracked as subjects made both rational and irrational financial decisions and as some but not all of them moved from positions of exuberance to appropriate caution. One finding from that study that was particularly interesting is that the subjects who became anxious as the simulated financial bubble grew very rapidly were more likely to make adaptive decisions compared to subjects who were ‘bulls’ charging ahead without the cautionary break applied by the anxious subjects.
Individuals are can be systematically different from one another in how they assign value. For example, special groups of subjects such as drug addicts (including patients addicted to alcohol) and violent criminals respond to immediate rewards like the children in Mischel’s studies. In gaming experiments they are far more likely to make irrational choices compared to normal controls and these decisions are associated with difference in the brain circuitry involved in making those decisions. They respond to immediate rewards rather than optimum long terms rewards and this pattern of behavior seems to be a metaphor that characterizes their destructive life pattern of behavior.
Their decision making is governed by brain systems that are active in high emotions states which are cognitively qualitatively different from the rational and more adaptive cool headed cognition ruled by planning, self-regulation and use of inhibition.
We have learned that all of us often make irrational economic decisions. We dramatically discount the value of what we might gain in the future. The further out in time in making valuations the bigger the discounted of value. If smokers were to get sick a year after smoking then smoking would be far less prevalent. Of course it is also important to not just look at time but also probabilities of consequences. A 1 in 5 chance of an early lung cancer death is a low cost for the satisfaction of a nicotine hit. After all when 1 in 5 is combined with 20 years later the value of smoking in the face of disease goes way up.
We exhibit huge individual differences in our propensity to make rational choices. Decisions made under conditions in which we are emotionally aroused are different (less reflective and more reflexive and based on activation of limbic system brain structures) than when we make choices using our cool cognitive system (based on executive functions of the frontal and prefrontal lobes of our brains). Learning to make rational choices often requires inhibiting immediate responses made in the context of emotional arousal. We learn (often not very well) to make rational rather than impulsive evaluations of the choices before us. Poor decisions can be part of the repertoire of very smart people. I can go on but will stop here except to point out that we now have the tools to study brain mechanisms that are the basis of rational and irrational decisions processes when we are confronted with economic choices.
Guarding against loss is considered of greater value than equivalent or even potential greater gains. When adults decide to hold on to a stock that has lost much of its value they would rather not invest in some equity that is likely to be a winner rather than take a loss. Imagining not losing is worth much more than a reward later. It isn’t rational but that is the point we are often not rational economic decision makers.
A whole society just like individuals can make irrational future discounting decisions. Going into debt now, even when the future consequences can be catastrophic is often the valuation of choice in personal and societal economies.
Much more later in my follow up report.