DEFINITION of ‘Neuroeconomics’
Neuroeconomics attempts to connect economics, psychology, and neuroscience to understand economic decision-making better. The fundamentals of economic theory were built under the assumption that the intricacies of the human brain would never be discovered. However, with advances in technology, neuroscience has produced methods of analyzing brain activity. Neuroeconomics has been broken down into four central areas of study; intertemporal choice, game theory, and decision making under risk and uncertainty. Each study identifies how humans balance their emotions and utility while faced with risk and uncertainty.
BREAKING DOWN ‘Neuroeconomics’
Fundamental to the rise of neuroeconomics is a need to mend the glaring holes in conventional economic theories. Economic decision-making, in the traditional sense, suggests investors will objectively evaluate risk and react in the most rational manner.
However, if history has told us anything, this has only perpetuated asset bubbles and subsequently, financial crises. That being said, neuroeconomics can provide insight into why humans do not act to optimize utility (and seemingly, irrationally). Typically, our emotions have a profound effect on our decision making. The brain often reacts more severely to losses than to gains, giving rise to irrational behavior. While emotional responses are not always suboptimal, they are rarely consistent with the concept of rationality. As neuroeconomicsbecomes more developed, we will be able to gain a better understanding of the mechanisms that influence decision-making.