Animal Spirits Affective and Deliberative Processes in Economic Behavior

1. Animal SpiritsAffective and Deliberative Processes in Economic Behavior George Loewenstein & Ted O’Donoghue

2. law political science history Demography ….. spending/saving insurance labor market behavior bargaining investing medical decision making gambling criminal behavior fertility/sex charity/altruism dieting addiction suicide Ed Lazear, "Economic Imperialism" Economic Journal,2000. "individuals engage in maximizing rational behavior"

3. The craving for power which characterizes the governing class in every nation is hostile to any limitation of the national sovereignty. This political power hunger is often supported by the activities of another group, whose aspirations are on purely mercenary, economic lines… Letter from Albert Einstein to Sigmund Freud (1932)

4. The craving for power which characterizes the governing class in every nation is hostile to any limitation of the national sovereignty. This political power hunger is often supported by the activities of another group, whose aspirations are on purely mercenary, economic lines… How is it that these devices succeed so well in rousing men to such wild enthusiasm, even to sacrifice their lives? Only one answer is possible. Letter from Albert Einstein to Sigmund Freud

5. The craving for power which characterizes the governing class in every nation is hostile to any limitation of the national sovereignty. This political power hunger is often supported by the activities of another group, whose aspirations are on purely mercenary, economic lines… How is it that these devices succeed so well in rousing men to such wild enthusiasm, even to sacrifice their lives? Only one answer is possible.Because man has within him a lust for hatred and destruction. In normal times this passion exists in a latent state, it emerges only in unusual circumstances; but it is a comparatively easy task to call it into play and raise it to the power of a collective psychosis. Here lies, perhaps, the crux of all the complex factors we are considering, an enigma that only the expert in the lore of human instincts can resolve. Letter from Albert Einstein to Sigmund Freud

6. The craving for power which characterizes the governing class in every nation is hostile to any limitation of the national sovereignty. This political power hunger is often supported by the activities of another group, whose aspirations are on purely mercenary, economic lines… How is it that these devices succeed so well in rousing men to such wild enthusiasm, even to sacrifice their lives? Only one answer is possible.Because man has within him a lust for hatred and destruction. In normal times this passion exists in a latent state, it emerges only in unusual circumstances; but it is a comparatively easy task to call it into play and raise it to the power of a collective psychosis. Here lies, perhaps, the crux of all the complex factors we are considering, an enigma that only the expert in the lore of human instincts can resolve. Letter from Albert Einstein to Sigmund Freud Freud’s response: “You have stated the gist of the matter in your letter--and taken the wind out of my sails!

7. And, another expert’s opinion… “Arguments must be crude, clear and forcible and appeal to emotions and instincts, not the intellect. Truth was unimportant and entirely subordinate to tactics and psychology.” Hermann Goering

8. Affect is also important in every-day economic activity.. • Advertising (that conveys no evident information) • Gambling (especially by people who also buy insurance) • Taking (and avoiding) the wrong risks • Helping the wrong victims • Non-self-interested political preferences – e.g., why poor people support tax cuts for the rich • Failure to reach agreement in negotiations – e.g.,nasty divorces • Self-control problems – e.g., dieting, drug addiction, crimes of passion, failure to practice safe sex, etc..

9. Affect once an integral part of economics (going by the label, ‘the passions.’)

10. "When we are about to act, the eagerness of passion will seldom allow us to consider what we are doing with the candour of an indifferent person. This.. fatal weakness of mankind is the source of half the disorders of human life. Theory of Moral Sentiments Adam Smith

11. passions Smith’s specific perspective (close to many contemporary ‘dual process’ models in psychology) Indulge! Would an honorable man do it? “impartial spectator”

12. Neoclassical economists aware of importance of affect: Human behavior, in general, and presumably, therefore, also in the market place, is not under the constant and detailed guidance of careful and accurate hedonic calculations, but is the product of an unstable and unrational complex of reflex actions, impulses, instincts, habits, customs, fashions and mob hysteria. In light of modern psychology "let reason be your guide" is apparently a counsel of unapproachable perfection. Jacob Viner, 1925 • but deterred from incorporating it into economics due to its perceived complexity, as well as problem that affect could not be measured directly “I hesitate to say that men will ever have the means of measuring directly the feelings of the human heart. It is from the quantitative effects of the feelings that we must estimate their comparative amounts.” W.S. Jevons, 1871

13. A century later, we know a lot more about affect.. Neuroscience methods: • Human • brain lesions, accidents, & lobotomies • Brain imaging • Animal • Electrical brain stimulation • Single-neuron measurement

14. And economists have started to propose formal models of affect Recent dual process models in economics: • Thaler & Shefrin, 1981 • Bernheim & Rangel, 2005 • Benhabib & Bisin, 2002 • Fudenberg & Levine, 2004

15. My research (three thrusts): Empirical: • Affect has the capacity to turn us into virtually different people -- including on the dimensions that economists care most about • People lack empathy for their own and others’ emotional states: “hot-cold empathy gaps” • Long-term decision-making is powerfully influenced in a non-normative fashion by transient emotional factors: ‘projection bias’ (Loewenstein, O’Donoghue & Rabin, QJE, 2003) Theoretical: Model of affect/deliberation interactions

16. Lerner, J. S., Small, D. A., and Loewenstein, G. (2004). Heart strings and purse strings: Carry-over effects of emotions on economic transactions. Psychological Science, 15(5), 337-41.

17. Life for the emotional is very different, comprised of dizzying revolutions of the clock, for what they want changes so rapidly that who they are is constantly in question… If I went to bed one night loving Chloe are awoke the next morning hating her, then who was “I”? Alain de Botton, On Love

18. My research (three thrusts): Empirical: • Affect has the capacity to turn us into virtually different people -- including on the dimensions that economists care most about • People lack empathy for their own and others’ emotional states: “hot-cold empathy gaps” • Long-term decision-making is powerfully influenced in a non-normative fashion by transient emotional factors: ‘projection bias’ (Loewenstein, O’Donoghue & Rabin, QJE, 2003) Theoretical: Model of affect/deliberation interactions

19. Hot-cold empathy gapsDrug CravingLouis Giordano, Warren K. Bickel, Eric A. Jacobs, George Loewenstein, Lisa Marsch, and Gary J. Badger. Procedure (simplified): • n=13 addicts receiving Buprenorphin (BUP) (methadone-like maintenance drug) • chose between extra dose of BUP or different money amounts, either to be received 5 days later • Made choice either right before receiving BUP (i.e., when deprived) or right after (when satiated) Prediction: Addicts will value delayed BUP more highly if choosing when they are currently craving than when they are not currently craving

20. Results

21. “The only trouble was the heat. The heat was tremendous and nowhere in Rome was hotter than Laura's apartment. She had been so eager to get back into her own place that she had forgotten how hot it would be. Heat is like that. In the course of winter unbearable heat cools in memory and becomes attractive, desirable. Now it was terribly hot.”Geoff Dyer (1997). Out of Sheer Rage.

22. My research (three thrusts): Empirical: • Affect has the capacity to turn us into virtually different people -- including on the dimensions that economists care most about • People lack empathy for their own and others’ emotional states: “hot-cold empathy gaps” • Long-term decision-making is powerfully influenced in a non-normative fashion by transient emotional factors: ‘projection bias’ (Loewenstein, O’Donoghue & Rabin, QJE, 2003) Theoretical: Model of affect/deliberation interactions

23. It is always thus, impelled by a state of mind which is destined not to last, that we make our irrevocable decisions. Marcel Proust, Remembrance of Things Past

24. My research (three thrusts): Empirical: • Affect has the capacity to turn us into virtually different people -- including on the dimensions that economists care most about • People lack empathy for their own and others’ emotional states: “hot-cold empathy gaps” • Long-term decision-making is powerfully influenced in a non-normative fashion by transient emotional factors: ‘projection bias’ (Loewenstein, O’Donoghue & Rabin, QJE, 2003) Theoretical: Model of affect/deliberation interactions

25. Central insight: Affect is important, but humans also have the ability to deliberate systematically about the consequences of their decisions  Model needs to incorporate interaction of affect and deliberation

26. Goal of paper: To formally model the role played by affect in human behavior and to trace out implications for economics – specifically: • Intertemporal choice • Decision under risk and uncertainty • Interpersonal decision-making (e.g., bargaining, charity, etc.)

27. Schematic representation of our model

28. Schematic representation of our model Proximity (e.g., Mischel et al.; VanBoven et al.)

29. Schematic representation of our model

30. Schematic representation of our model

31. Schematic representation of our model ?

32. Some notation: • x consumption • s stimuli • a(s) affective states induced by stimuli • c(s) cognitive states induced by stimuli Affective optimum (M stands for ‘motivation’): Deliberative optimum: Proximity: important source of xD ≠ xA Utility cost of x ≠ xA: h(W,σ)*[M(xA,a)–M(x,a)] where, W willpower σ factors that weaken or bolster deliberative system -- e.g., stress & cognitive load h(.) cost of willpower

33. Generates behavior somewhere in between the deliberative optimum and the affective optimum, depending on relative strength of the two systems as captured by the cost of willpower h(W, σ) h(W,σ)=0 deliberative system in complete control h(W,σ)=∞ affective system in complete control • General modeling strategy: • Assume that U function is well-described by normative models (e.g., expected value, discounted utility, utilitarianism) • Adapt assumptions about the M function from psychology research

34. Ability to exert willpower also depends on prior exertions of willpower (Baumeister et al., 1999-2004). willpower dynamics: wt≡M(xtA,at)–M(xt,at) willpower exerted at time t Wt+1 = f(wt,Wt) with f declining in w

35. Three applications • Intertemporal Choice • Risk • Social preferences

36. Intertemporal Choice Assume: • deliberative system cares equally about all outcomes • affective system completely myopic

37. Free 2 s 12 s intertemporal choice Neural underpinnings of intertemporal choice McClure, S.M., Laibson, D.I., Loewenstein, G.and Cohen, J.D. (2004). Separate neural systems value immediate and delayed monetary rewards. Science, 304, 503-507

38. A 10 MPFC VStr MOFC PCC T13 0 x = 4mm y = 8mm z = -4mm PCC VStr B MOFC MPFC 0.4 0.2 % Signal Change 0.0 -0.2 -4 0 4 8 Time (s) d = Today d = 2 weeks d = 1 month Figure 1

39. A B VCtx PMA RPar 1.2 DLPFC RPar 0.8 % Signal Change 0.4 LOFC 0.0 x = 44mm -4 0 4 8 Time (s) PMA VCtx DLPFC VLPFC LOFC SMA x = 0mm 10 0 T13 d = Today d = 2 weeks d = 1 month Figure 2

40. A B 100% 4.5 PMA VCtx RPar 4.0 75% RT (s) P(choose early) 3.5 50% 1.2 3.0 25% 0.8 0% 2.5 1-3% 5-25% 35-50% Difficult Easy % Signal Change R’ vs. R Decision 0.4 C LOFC DLPFC VLPFC 0.0 -4 0 4 8 Time (s) Difficult Easy Figure 3

41. 0.05 d areas Normalized Signal Change 0.0 b areas -0.05 Choose Late Choose Early Figure 4

42. Intertemporal choice conclusions • hyperbolic time preference results from affective response to immediate outcomes • hyperbolic time preferences & temptation preferences extreme special cases of our model (reality probably lies in-between) • model generates novel prediction that time preference will vary over time in response to: • willpower depletion • cognitive load • proximity of temptations

43. Shiv, B. and Fedorikhin, A. (1999), "Heart and Mind in Conflict: Interplay of Affect and Cognition in Consumer Decision Making,"Journal of Consumer Research, Vol. 26 (December), 278-282. • Cognitive/deliberative mental processing resources manipulated by having people keep a 2-digit or 7-digit number in mind as they walk from one room to another • On the way, subjects face choice between piece of cake or fruit-salad

44. Risk • Many examples of divergences between affective and deliberative evaluations of risks – e.g., flying versus driving

45. Shiv, B., Loewenstein, G., Bechara, A., Damasio, H., and Damasio, A. (2005), “Investment Behavior and the Dark Side of Emotion,” Psychological Science. Illustrates the (potentially negative) influence of affect on risky decision-making • Subjects: 15 patients with lesions in regions critical for emotional processing (amygdala, orbitofrontal, and insular/somatosensory cortex); 15 normal controls, & 7 patient controls with lesions in brain regions not associated with emotional processing • Procedure: • Begin with $20; play 20 rounds of gambling task • Each round: Can put $1 at risk: 50/50 chance of losing the $1 or getting $2.50 (e.v. of gambling is $1.25)

46. Results: % gambling

47. Normals responded to both winning and losing by subsequently not gambling Percent gambling conditional on action and outcome of prior round

48. Modeling risky decision-making • Assume: • Deliberative system: EV • Affective system: Weights all possible outcomes equally • (p+h)/(1+Nh) > p for p < 1/N and (p+h)/(1+Nh) < p for p > 1/N) • s-shaped probability weighting: small probabilities overweighted; large probabilities underweighted • Probability weighting more s-shaped for affective outcomes than for non-affective outcomes (Hsee & Rottenstreich,2003; Ditto, Epstein & Pizarro, forthcoming) • Acting on one’s cognitive appraisals of, as opposed to reflexively responding to emotional reactions to, risks, can require willpower

49. Altruism Adam Smith: Let us suppose that the great empire of China, with all its myriads of inhabitants, was suddenly swallowed up by an earthquake, and let us consider how a man of humanity in Europe, who had no sort of connection with that part of the world, would be affected upon receiving intelligence of this dreadful calamity. He would, I imagine, first of all express very strongly his sorrow for the misfortune of that unhappy people, he would make many melancholy reflections upon the precariousness of human life, and the vanity of all the labours of man, which could thus be annihilated in a moment… And when all this fine philosophy was over, when all these humane sentiments had been once fairly expressed, he would pursue his business or his pleasure, take his repose or his diversion, with the same ease and tranquility as if no such accident had happened. The most frivolous disaster which could befall himself would occasion a more real disturbance. If he was to lose his little finger tomorrow, he would not sleep to-night; but, provided he never saw them, he will snore with the most profound security over the ruin of a hundred millions of his brethren.. Why, then do people often behave humanely toward others they don’t know? Smith’s answer: “reason, principle, conscience, the inhabitant of the breast, the man within, the great judge and arbiter of our conduct” – i.e., the impartial spectator

50. We model altuism by assuming: • deliberative system evaluates outcomes based on utilitarianism with an extra weight on self • affective system can deviate from that rule in either direction • ↓willpower(e.g., due to stress or load) shift toward affective optimum