Saturday, October 2, 2010

Number's up for the far side of the brain

Try this holiday quick quiz: A bat and a ball cost $1.10 in total. The bat costs $1 more than the ball. How much does the ball cost? If your answer is 10, sorry, you're wrong.

(If the ball costs 10 then the bat costs 90 more than the ball not $1 more.) But don't feel bad. Even the brightest people who read that sentence tend to get the wrong answer.

But don't feel good if, having taken a closer look at the question, you've managed to work out the right answer must be 5. When your brain's in alert mode it's not a difficult sum.

No, the point of this famous experiment is to show that most people answer the question using the wrong hemisphere of their brain.

As Ian McAuley, a lecturer in public sector finance at the University of Canberra, explained in a paper on behavioural economics delivered to the Economic Society's Australian Economic Forum, "sound decision-making often rests not so much on technical skills (anyone can solve the bat and ball experiment with basic algebra or with trial and error) but more on being able to identify the nature of the problem".

That little experiment is an introduction to a relatively new branch of economics, "neuro-economics", which is the application of the techniques of neuroscience - the study of the brain and the nervous system - to economics.

A lot of the pioneering work in neuro-economics has been done by Colin Camerer, a professor of behavioural economics at the California Institute of Technology. McAuley identifies seven significant findings of Camerer and his colleagues.

First, how impatient we are, how much risk we're prepared to run and how generous we are is "domain-specific". We can be impatient in some things, but not in others; willing to take risks in some areas but cautious in others. A person might be highly disciplined about saving, for instance, but quite impulsive about diet.

But we're often unaware of how inconsistent we are. We may think of ourselves as scrupulously honest because we'd never steal and would always return a wallet we found, forgetting that we take home office stationery because this is "not the same thing". That's why it's always hypocritical to accuse others of hypocrisy - all of us are hypocrites.

Second, many of us value money in its own right, not just for what it will buy. People commonly suffer from "money illusion", forgetting to allow for inflation when comparing amounts coming from different years. And most people suffer from "loss aversion" - we hate losing $100 much more than we love gaining $100.

Point is, we suffer those conditions more when actual money is involved than when valuable tokens, such as frequent flyer points, are involved. We behave differently when spending cash to when paying by debit card.

I always convert my credit card reward points into David Jones shopping vouchers. A certain party well known to me uses these vouchers with gay abandon because they're "free". (They may have been easily acquired, but if you regularly buy a fair bit from that shop, this doesn't stop them being as valuable as money.)

A third lesson from neuro-economics is that our brains seem to have different systems for "wanting" and "liking". Wanting is about motivation, whereas liking is about pleasure. Think of the kid who begs and begs his parents to buy a pet - or a guitar - then loses interest in it within a few days. There was a yawning gap between wanting and liking.

All of us have times when we lack the motivation to do something we know we'd enjoy. That's almost the definition of being depressed. It's given rise to a psychological therapy called PAT - pleasant activity training: make a list of the things you enjoy doing and then do them more often. Don't scoff.

Fourth, we also seem to have two mental systems for making decisions. Daniel Kahneman, the psychology professor who won the Nobel prize for inventing behavioural economics, says System 1 is "fast, automatic, effortless, associative and difficult to control or modify".

System 2, on the other hand, is "slower, serial, effortful and deliberately controlled ... also relatively flexible and potentially rule-governed". If, for instance, I sat you down to do a dozen of those bat-and-ball style questions, and provided feedback, you'd quickly learn to read the question carefully before blurting out an answer and would probably produce a pen and paper to help you.

The lesson here is that too many demands on our controlled, cognitive system (System 2) decease its capacity to make good decisions. "Salespeople promoting a product can load our mind with minor but complex technical details in order to distract us from more important considerations," McAuley says.

His fifth lesson from neuro-economics is that we use the left hemisphere of our brain to assess probabilities, but the right side to process logic. This is why we often don't see the logical errors resulting from our "conjunctive bias".

Huh? Say I give you a description of Paula and her circumstances. She may not sound like the sort of person who'd work for an insurance company, but if I tell you she's taken an entry-level office support job in an insurance company to accumulate some money, you'll be more inclined to believe it - even though, logically, it has to be less likely because it's more specific.

Humans are a story-telling animal, so we tend to believe good yarns which have a coherent structure, McAuley says.

Sixth, in situations where we have to decide whether to be trusting or distrusting, the decision we make can be influenced by our hormone cycles. (So not only are we often less than logical, we're not even conscious of why we jump the way we do.)

Finally, even if we strive to avoid stereotyping people according to their race or gender, we automatically develop stereotypes through mental associations of which we have no awareness.

In his fascinating book Blink, Malcolm Gladwell tells how he repeatedly took a test designed to show any racial prejudices, trying to improve his score because it indicated he was prejudiced, even though his mother was Jamaican (and he sports a fabulous afro).

As McAuley observes, this finding has worrying implications for discrimination in employment. It suggests employers' decisions about who to hire can be affected by prejudices without them being aware of it.

Clearly, economists have a lot to learn from the burgeoning study of how our brains work.