Nemmers Prize talk May 7, 2005 Neuroeconomics of Games and Decisions* Colin Camerer, Caltech Neuroeconomics of Games and Decisions* Colin Camerer, Caltech Neuroeconomics: Neuroeconomics: Grounding micro-economics in details of neural activity Grounding micro-economics in details of neural activity Part of behavioral economics (using psychology to inform theories of rationality limits) Part of behavioral economics (using psychology to inform theories of rationality limits) Part of experimental economics (new techniques) Part of experimental economics (new techniques) Part of neuroscience (higher order cognition) Part of neuroscience (higher order cognition) *”Neuroeconomics” Camerer, Loewenstein, Prelec J EconLit (85 pp), Scan J Econ (25 pp), “Why economics needs brains”

Nemmers Prize talk May 7, 2005 Collaborators Caltech: Meghana Bhatt, Ming Hsu, Ralph Adolphs, Cedric Anen, Steve Quartz Caltech: Meghana Bhatt, Ming Hsu, Ralph Adolphs, Cedric Anen, Steve Quartz Iowa: Dan Tranel Iowa: Dan Tranel Baylor: Brooks King-Casas, Damon Tomlin, Read Montague Baylor: Brooks King-Casas, Damon Tomlin, Read Montague

Nemmers Prize talk May 7, 2005 Three directions in neuroeconomics I. Support for rational-choice models I. Support for rational-choice models “Belief” neurons “Belief” neurons Expected-value neurons Expected-value neurons “Monkey shopping” satisfies GARP “Monkey shopping” satisfies GARP II: Support for behavioral alternatives II: Support for behavioral alternatives Loss-aversion in monkey shopping Loss-aversion in monkey shopping Learning in trust games Learning in trust games Ambiguity vs. risk (Knight, Ellsberg) Ambiguity vs. risk (Knight, Ellsberg) III: New concepts III: New concepts Equilibrium as a “state of mind” Equilibrium as a “state of mind” Neural correlates of “strategic IQ” Neural correlates of “strategic IQ” Biological basis of demand Biological basis of demand

Nemmers Prize talk May 7, 2005 Economically-important regions of the human brain

Nemmers Prize talk May 7, 2005 Cingulate (yellow), orbitofrontal (pink), amygdala (orange), somatosensory (green), insula (purple)

Nemmers Prize talk May 7, 2005 Important facts about the brain Functional “modularity”… Functional “modularity”… …but “plastic” esp. in childhood …but “plastic” esp. in childhood Behavior depends on circuits Behavior depends on circuits Human brain is primate brain + neocortex Human brain is primate brain + neocortex Language, social organization (institutions) Language, social organization (institutions) Infants, fraternity parties show similarity Infants, fraternity parties show similarity Many biological functions are automated; conscious attention is scarce (flicker paradigm) Many biological functions are automated; conscious attention is scarce (flicker paradigm)

Nemmers Prize talk May 7, 2005 I: Rational choice in the brain Midbrain neurons anticipate reward (L), encode value function V(.) learning (R) (Schultz, Dayan, Montague Sci 97)

Nemmers Prize talk May 7, 2005 Neuron firing rates (y axis) encode expected value (x-axis) (Glimcher)

Nemmers Prize talk May 7, 2005 Monkeys play mixed equilibrium as humans do (Dorris-Glimcher Neuron 04)

Nemmers Prize talk May 7, 2005 Capuchin monkeys respond to prices (Keith Chen et al 05)

Nemmers Prize talk May 7, 2005 II: Behavioral economics in the brain Monkey choices are sensitive to reference points Monkey choices are sensitive to reference points Reference point (initial food reward endowment) Reference point (initial food reward endowment) Outcome 1 1 (1,2) (1,2) Choice % 79% 21% 71% 29%

Nemmers Prize talk May 7, 2005 Design goal: Link stimuli with unobserved parametric processes/variables with circuitry 0-step thinking 1-step thinking Equilibrium C=br(B) w(red)-P(red)

Nemmers Prize talk May 7, 2005 Overview of fMRI

Nemmers Prize talk May 7, 2005 Data transformations RealignmentSmoothing Normalisation General linear model Statistical parametric map (SPM) Image time- series Parameter estimates Design matrix Template Kernel p <0.05 Statisticalinference

Nemmers Prize talk May 7, 2005 Ambiguity Aversion (with Ming Hsu et al) This material is in review and cannot be publicly circulated at this time. This material is in review and cannot be publicly circulated at this time.

Nemmers Prize talk May 7, 2005 III: New ideas Limited planning in bargaining  Limited planning in bargaining  limited steps of thinking Equilibrium as a “state of mind” Equilibrium as a “state of mind” Biological bases of demand Biological bases of demand

Nemmers Prize talk May 7, 2005 Rubinstein-Stahl alternating offer shrinking-pie bargaining 1 offers division of $  accept 1 offers division of $  accept ↓ 2 offers division of  accept 2 offers division of  accept ↓ 1 offers division of  accept 1 offers division of  accept↓ (0,0) (0,0)

Nemmers Prize talk May 7, 2005 Limited planning in bargaining (Science, 03)

Nemmers Prize talk May 7, 2005 Cognitive hierarchy thinking in games (Camerer, Ho, Chong, QJE 04) Step 0 players choose randomly Step 0 players choose randomly Step k players have beliefs g k (h) Step k players have beliefs g k (h) Step k players choose s* i (k)= argmax s Σ h g k (h)π i (s,s*(h)) Step k players choose s* i (k)= argmax s Σ h g k (h)π i (s,s*(h)) One-step-below g k (k-1)=1 One-step-below g k (k-1)=1 Nagel (1995), Stahl-Wilson (1995), Costa-gomes-Crawford-Broseta (2001) Nagel (1995), Stahl-Wilson (1995), Costa-gomes-Crawford-Broseta (2001) Nornalized overconfidence g k (h)= g k (h)/Σ h k-1 g k (h) Nornalized overconfidence g k (h)= g k (h)/Σ h k-1 g k (h) g k (h)= 0 for h>k g k (h)= 0 for h>k Link to hierarchical QRE (Palfrey-Rogers-Camerer, on this computer) Link to hierarchical QRE (Palfrey-Rogers-Camerer, on this computer)

Nemmers Prize talk May 7, 2005 Limited equilibration Beauty contest game N players choose numbers x i in [0,100] N players choose numbers x i in [0,100] Compute target (2/3)*(  x i /N) Compute target (2/3)*(  x i /N) Closest to target wins $20 Closest to target wins $20

Nemmers Prize talk May 7, 2005

Neural correlates of iterated belief (Bhatt-Camerer GEB in press) 8 dominance-solvable games. 8 dominance-solvable games. C, B, 2B in random order for each game C, B, 2B in random order for each game Paid for choice (x$.30) or accuracy B, 2B ($15) against live opponent outside the scanner. (Enables measure of scanner on behavior.) Paid for choice (x$.30) or accuracy B, 2B ($15) against live opponent outside the scanner. (Enables measure of scanner on behavior.) N=16 Caltech community students N=16 Caltech community students

Nemmers Prize talk May 7, 2005 Example: 1-step (easy) game; B dominates A. L-R payoff separation allows “eye tracking”

Nemmers Prize talk May 7, 2005 Conformity to equilibrium: There are many nonequilibrium trials Note: C matches 2B more often than B matches 2B

Nemmers Prize talk May 7, 2005 Equilibrium is a state of mind: Expected reward theory of mind + (in equilibrium ↓) (↓ out-of-equilibrium) Equilibrium is a state of mind: Expected reward theory of mind + (in equilibrium ↓) (↓ out-of-equilibrium)

Nemmers Prize talk May 7, 2005 Subject complaining after an experiment (Zamir, 2000)

Nemmers Prize talk May 7, 2005 Ultimatum games: This is your brain on unfairness (Sanfey, Rilling et al, Sci 13 March ’03)

Nemmers Prize talk May 7, 2005 Consistent 2 nd -order beliefs (c=2b) vs inconsistent (“false”) (c≠2b) 2 nd -order belief consistency differential activates dorsolateral prefrontal cortex (DLPFC) 2 nd -order belief consistency differential activates dorsolateral prefrontal cortex (DLPFC) DLPFC also seen in ultimatum games after low offers (“intentions matter”) DLPFC also seen in ultimatum games after low offers (“intentions matter”) DLPFC is part of 2 nd - order belief circuitry? DLPFC is part of 2 nd - order belief circuitry?

Nemmers Prize talk May 7, 2005 Deactivation in insula and high strategic IQ Strategic IQ (x-axis): How much you earn from choices & beliefs Strategic IQ (x-axis): How much you earn from choices & beliefs Correlated (-) with activity in L insula in choice task Correlated (-) with activity in L insula in choice task  Are overly self- focussed people poor strategic thinkers?  Are overly self- focussed people poor strategic thinkers?

Nemmers Prize talk May 7, 2005 Insula and low strategic IQ Strategic IQ (x-axis): How much you earn from choices & beliefs Strategic IQ (x-axis): How much you earn from choices & beliefs Correlated (-) with activity in L insula in choice task Correlated (-) with activity in L insula in choice task  Are overly self- focussed people poor strategic thinkers?  Are overly self- focussed people poor strategic thinkers?

Nemmers Prize talk May 7, 2005 Correlates of higher strategic IQ

Nemmers Prize talk May 7, 2005 New ideas: Biological basis for demand Economics takes demand as given. But… Economics takes demand as given. But… Influence of advertising Influence of advertising Familiarity and habit formation (“tight playlist” radio stations) Familiarity and habit formation (“tight playlist” radio stations) Imitation of movie stars/TV shows Imitation of movie stars/TV shows “LA Law”  boom in law school applications “LA Law”  boom in law school applications Sense-making drive  demand for “closure”  lawsuits Sense-making drive  demand for “closure”  lawsuits Media: “If it bleeds, it leads”, NASCAR races Media: “If it bleeds, it leads”, NASCAR races Does the amygdala control the TV remote? Does the amygdala control the TV remote? Addiction: Is golf or shoe-shopping like heroin? Addiction: Is golf or shoe-shopping like heroin? Labor market discrimination (Phelps et al)? Labor market discrimination (Phelps et al)? Unfamiliar black faces activate white student amygdalae Unfamiliar black faces activate white student amygdalae

Nemmers Prize talk May 7, 2005 Conclusions I: Rational choice processes in the brain I: Rational choice processes in the brain Monkey belief neurons, games, shopping Monkey belief neurons, games, shopping II: Behavioral economics in the brain II: Behavioral economics in the brain Monkey loss-aversion Monkey loss-aversion Ambiguity activates amygdala-OFC, risk striatum Ambiguity activates amygdala-OFC, risk striatum Lesion patients with OFC are “rational”…for the wrong reason? Lesion patients with OFC are “rational”…for the wrong reason? III: New ideas from neureconomics III: New ideas from neureconomics Limited strategic thinking  equilibrium as a “state of mind” Limited strategic thinking  equilibrium as a “state of mind” Skill (strategic IQ) correlated + with precuneus, caudate, Skill (strategic IQ) correlated + with precuneus, caudate, correlated - with insula Biological basis of demand Biological basis of demand

Nemmers Prize talk May 7, 2005 Activation in cingulate cortex & spindle cell density