Daniel L. McFadden (2014) - The New Science of Pleasure

At the beginning of economics the consumer was central in economic thinking and remains central today as the one side of the market and the target of economic policy. And the welfare of consumers is a primary concern. Now, the neoclassical consumer theory is largely a finished subject but there are a lot of new measurements coming in to economics from other disciplines that challenge the neoclassical model. What I want to do today is summarise at a very high level some of those findings and try to draw out some of their implications for where the theory of the consumer may go over the next few decades. So, the classical idea of course was that people are utility maximisers, pure and simple. That was Bentham’s view, it was Edgeworth’s view. And Edgeworth wistfully called for a hedonometer that could make the science of pleasurists quantitative as the science of energy. Hence the title of this talk: The new science of pleasure. It’s a play on Edgeworth and the use of new measures. Now, the place of utility and our preferences in the economic theory of choice is illustrated in this diagram. In the classical and neoclassical views utility is a pretty central notion. It’s influenced by a variety of factors. It leads through some process of choice process to actual choices and to reveal, if you like, backwards to reveal the utility and measures of wellbeing. In this diagram the things that are marked in red correspond to the classical and neoclassical model. Those are the main linkages. There’s some factors in grey here which were factors in classical utility theory and had been sort of greyed out in neoclassical theory but are not contradictory to it. Could be brought back in. And then there’s some things in blue which are not in either classical or neoclassical utility theory but are worth talking about in terms of what you can measure and what impacts those measurements will have on what you believe is going on. So, here’s a question, a simple question. What is utility? Here’s some possibilities. One is that it’s a physiological sensation determined by the neurological hardware and chemistry of the brain and it determines choice. That is the classical view of Bentham, Edgeworth. And it’s the view of some modern behavioural and neuroeconomists like Ernst Fehr and David Laibson. A second possibility is that utility is a kind of a cognitive accounting. It’s the result of learning, reasoning and calculation. And if you want to think of it you could think of it as a kind of a mental spreadsheet that you use to work out the value of alternatives. And it explains choice in the sense that, at least in the neoclassical sense, that if you look back at choices and ask could there be any organising principle that governs choice. If neoclassical theory is right, yes, you would find something which people behave as if they were maximising. A third possibility is that the term utility is really a short hand for the aggregated and proximate effects of a variety of heuristics and social effects that are themselves nudged by evolution towards roughly self-protecting choice behaviour. So people may proximally behave like utility maximisers, at least in familiar situations, but perhaps simply because selection has led them to, led people to use heuristics which work rather than being a disaster in those situations. So that’s the view of Herb Simon and among contemporary behavioural economists for example Colin Camerer, Richard Thaler. And finally utility might be simply a measurement, some kind of response on a psychological scale to a question such as how happy are you right now. And that's the approach to utility that Danny Kahneman and Alan Krueger had taken. What I want to do is describe some of the new data and its implications for what seems to be true about these various views of utility. First quickly classical insights. Bentham and Edgeworth, the classical utilitarians, associated utility with process and with the stream of sensations. They did not associate it with a final vector of consumption goods. Also Bentham said that utility of an event was associated with its intensity, duration, certainty or uncertainty and propinquity or remoteness. So already in Bentham you have the ideas of discounted present value of a felicity stream and of anticipated expected utility. Sociality was an important consideration in all of classical utility theory. In the words of Edgeworth the welfare of family and friends, reciprocity and altruism were all fully accounted for in the classical utility theory. In the neoclassical view, neoclassical consumer theory narrowed the things that utility can depend on. That was mostly simply to get something that was analytically tractable. But the idea now became that utility was associated with final consumption vectors. Process dropped out. The idea that utility itself was something that was dynamic and changing dropped out. Also associated with the neoclassical view is the idea that people form perceptions or beliefs and they maximise in many versions expected future utility. At one point it is noticed that, well, in most text books, in most studies of consumer behaviour you don’t see explicit dependence on experience and memory. There’s nothing in the neoclassical theory which precludes the possibility that utility does depend on those through some kind of state process. Now, the behavioural re-evaluation of consumer of consumer decision making I think starts from the following observation. With rational calculation we cannot be harmed by choice and trade. People should relish choice and welcome all the opportunities offered by markets. Yet we’re in fact challenged by choice. We use all kinds of ways to avoid having to make choices such as procrastination. And one of the reasons for it is that there are risks associated with making choices. There’s the risk that comes from the market itself. We don’t know exactly what’s in the box. There’s personal risk. We don’t know until, often until we do it whether we actually like what’s in the box. And there are social risks. We have to get the box from someone else and that involves dealing with them personally and that is not always a comfortable interaction. I would give you an example of how risk influences consumers. This is an experiment that I did some time ago in a large undergraduate class. And it in itself is based on earlier behavioural experiments. Half of a class of 345 students... Everyone was given a chit and half of the chits said you’re now endowed with 1 pencil. And the other said sorry you don’t get a pencil. And then a Vickery double sealed-bid uniform-price double auction was immediately opened. And the students understood or at least had it explained to them that in such an auction that it wasn’t rational for them to bid exactly what the pencil was worth to them. And the market was actually opened and cleared. What you would expect in this situation is that about half the chits for pencils would have gone to people whose values were in the lower half of the class. And those in aprieto of achieving market trade, market reallocation, those should trade. So about half the 172 pencil chits should have traded. And in fact 32 traded, far fewer than should be expected for efficient market allocation. The median bid price of buyers was 10 cents. The median bid price for sellers was a dollar. Whereas one would expect again by chance they should be about the same. So what’s happening here? Either people somehow are almost instantaneously reacting to the possession of a chit for a pencil by saying that my preferences have been profoundly altered by the presence of this asset. Or people don’t like markets. They’re not willing to trade. They have agoraphobia. They’re afraid of markets. And I think that people are in fact afraid of markets. And it influences research allocation. In a lot of economics that we do we assume benignly that consumers will do their job on their side of the market and do the trading necessary to do efficient allocations. I think it’s simply not true. Now, what can you say about the failures such as the one I’ve just described to apparent failures of the economic rationality. First of all there are a number of experiments that show that consumers look like they’re pretty neoclassically rational when they are making choices among familiar alternatives whose consequences are immediate and significant. But as soon as they start involving choices and trades where the consequences are minor, are remote in time, low probability or are ambiguous, then things tend to fall apart. One comment, Herb Simon talked about bounded rationality. And his notion was that consumers should be rational except when the computation got too hard. And then they would use some kind of approximations. What we see here is a kind of bounded rationality in which people actually do reasonably well when the stakes are high. But when the stakes are low or ambiguous or remote, that’s when things fall apart. That’s when rationality tends to fail. Secondly social environments matter in consumer behaviour. The notion that consumers care only about their own consumption is simply not borne out by experiments. And social approval and sanctions are important factors in how people feel, how happy people are, how they feel about their consumption. There are many anomalies in behaviour seen to be associated with errors in perception. That is people have imperfect recall in interpretation of their memories or past experience. And they also are quite inconsistent in their formation of personal probabilities. Now, there also are anomalies that come out of short cuts in the decision making. Finally one comment. If choices become too familiar they tend to become automatic. And automatic choices, because they’re not really conscious, become quite resistant to minor changes in the environment. So one source of failures of rationality in any neoclassical sense is that things may get too easy. Also as another source. Now what about new measurements and a possible response to Edgeworth’s call for a hedonometer? There are 3 fields whose results have been very useful coming into economics and economists, as I’m sure many of you know, have themselves gone and worked in these fields. And there is now a lot of collaboration across disciplines. The 3 are sociology and I mean that broadly to include evolutionary biology and anthropology, cognitive psychology and brain science. And what I’m going to do in my coming minutes is to try to give a little summary of what’s coming out of each of these. First of all in sociology there are evolutionary stories from evolutionary biology. While interdependence of animals across kinship groups and species is fairly common, specialisation and trade outside kinship groups is particularly human. Trade seems to have started very early in human evolution. And the reason that appears to be the case is that the brain circuitry associated with trade in particular the trust relationships required for trade use the same brain circuitry as the trust relationships required for sexual and maternal bonding. Those circuits just get reused so that sex and trade do exactly the same thing to the pleasure centres of the brain. What’s the evidence for these views? Language and trading activities occur even in extremely isolated human societies. Second, if you play the trust game and treat people with the neuro transmitter oxytocin which is associated with trust, you get different kinds of players in the trust game. In the ultimatum game you also see internalised norms for reciprocity and altruistic punishment. So humans have evolved to live in social networks. And what they seem to care about, what seems to make them happy, if you want to use that term, is very much rooted in their social milieu. Social networks are important because they are sources of information because within a network effort is reduced and risk is reduced. And satisfaction advice and approval of others are very important in driving choice behaviour. The evidence comes from study of balkanised social networks and consumer behaviour within those networks. And you get very clear patterns in studies of things like the kind of cell phone you buy, the type of contraceptive you use. All kinds of things like that are dependent on your little piece of... your little social network. You get equilibrium, market equilibria which are distinctly different across different social networks. And incidentally it’s clear that these social networks do not have unique equilibria in terms of market consumer behaviour, a major issue for modelling consumer behaviour. Now secondly from cognitive science, from the psychologists there is now decades of experiments originally started by Kahneman and Tversky but now the domain of a wide variety of behavioural economists. There is so much of this that I’m not going to try to talk about it. I have some slides here which are probably invisible. But they are contained in the original paper. There are a few of these marked in red and the reason that’s so is that I’m going to come back to those at the end when I talk about some of the findings from brain science. But just these cognitive experiments look at various things. Whether people understand the choice task they’re given, how they retrieve memory or experience and process it to decide what’s good and what’s not. How they go about forming beliefs or judgements. What the process is and finally how they actually make decisions. What goes into that? And I guess if you had to characterise it in one sentence, there are a lot of mistakes that people make. Many of them can be attributed to failures to form consistent perceptions. But not all. Now what about brain science? What does it bring? This is the area which, when economists get involved, is called neuroeconomics. First as I mentioned before the trust relationships required by trade are associated with primitive brain functions that arguable have an evolutionary foundation because they’re sighted in the mid brain and the circuitry is the same in humans and wolves and other mammals. So it’s clearly not something that’s associated with the particular features of... necessarily with the particular features of language and rationality that we associate with humans. Importantly humans as well as other animals are on a hedonic treadmill. You quickly zero out where you are and respond to changes from where you are experiencing pleasure from gains and pain from losses. And that’s where your attention is focused. It’s focused on changes relatively to your reference point not on the reference point itself. Again there’s an evolutionary story which explains this. Where you are when you start is basically at some cost. Where you go next, whether it’s a pleasure from finding some grapes or pain from being attacked by a lion, are things where your attention is very important to your survival. And so it’s easy to see how these things might have been selected and emphasised in human evolution. Because of this hedonic treadmill and its attention, one can characterise it. It’s not the pursuit of happiness, it’s the happiness of pursuit that people really care about. Interestingly pleasure and pain. There’s neuro circuitry which records pleasure and pain. It’s pretty clearly identifiable. Pleasure and pain are treated in separate circuitry. So they’re not really the same. And they’re not recorded, netted on a single scale it appears. By the way Bentham always talked about pleasure and pain as 2 different things. And it seems like he might have had some foresight about that. Secondly functional MRI studies show that decisions involving gains or losses are processed in different parts of the brain. And decisions involving immediate gratification versus delayed gratification are also processed in different parts of the brain. So in summary there seems to be a physiological basis in particular for the kinds of cognitive anomalies that appear consistently in cognitive psychology such as endowment effects, asymmetric loss aversion and hyperbolic discounting. One way to characterise it is the brain is a committee and the communications within the members of that committee is imperfect. And so you see decreases where things get shifted from one committee member to another. You get some times inconsistencies. I’ve got a few experiments I’d like to describe. An interesting one is by a neurologist named Ivan Diamond and his associates at UCSF. And they studied the efficacy of neuroblockers for addiction. I should say one word about how addiction works. Addiction comes primarily from the anticipation of a hit. It’s the rush of dopamine associated with anticipating having a cigarette or having a drink which is the irresistible thing that drives people to try to get hits over and over. One of the ideas of controlling addiction is to try to block that rush of dopamine associated with anticipation. What Diamond and his associates did was open a bar at the University of California and invite alcoholics to come in and gave them chits and they could go to the bar and buy drinks. These alcoholics were administered various blockers, possible blocking molecules and then their rate of purchase of alcohol was taken as a measure of the efficacy of the blocker. Ok that was useful for them. The important lesson from that analysis for us was a direct physiological relationship between the pleasure circuitry in the brain and economic demand behaviour. Another example, I referred to this a little bit earlier. Ernst Fehr and associates find that the offers of principles in the trust game who were treated with the trust hormone oxytocin are more generous than the offers of principles treated with a placebo. So that again the presence of a neurotransmitter which promotes this kind of bonding or trust turns out to have a direct, immediate effect on economic choice behaviour. And play an economic game. And finally a new paper just published about 10 days ago by Robert Rutledge finds that stated experienced utility increased activity in dopamine receptor areas of the brain and deviations from expectations in the outcomes of choices that have random payoffs are all significantly correlated. This is all done by essentially putting people in a functional MRI machine and asking them the question how happy are you right now. You can imagine that you have to have a little bit of reference point zeroing out to even ever be happy in an MRI machine but nevertheless it works. And what it shows is that stated experiences about utility, the physiological measures of pleasure circuitry in the brain and choice behaviour are all related. And it also shows something else which I think is quite interesting which is that what we think of as homeostasis to the reference point is determined by what you expect to get from choices and the deviations from expectation. So again it’s gains or losses but the gains or losses are measured from what you expect to happen. Some conclusions from brain science. Activity in the areas of the brain associated with pleasure and pain receptors in neurotransmitters can be interpreted as determining 1 or 2 dimensions of happiness. These centres are in the primitive midbrain. The same in humans as in wolves or monkeys or chickens even. Thus their adaptation in humans to guide choice and trading behaviour seems to have occurred at an early stage of evolution. Consumers do make choices that tend to be associated with increased pleasure or reduced pain. That’s the physiology that Bentham anticipated. But the context of choice determines where in the brain options are processed and how immediate and seamless the connection is between choice and pleasure centre activity. It’s not the case that choice is automatically utility maximised. And there’s not a single utility scale. And there’s not a clear circuitry that leads from where choice information is processed to the pleasure centres of the brain. Finally we adapt a homeostasis. And what really lights up our brain, this sense of what a functional MRI shows is where energy is being expended is anticipation of gains or losses. The focus of our attention, the way we process visual images, our uses of analogies and heuristics in making choices are I think fully consistent with an evolutionary story that the brain is adapted to the functions that are needed for life in a risky social environment in which there is specialisation and trade. Do we have a hedonometer? Well I’ll quickly try to give you an answer. One possibility is to simply ask people how happy they are right now. And the question is, is that actually a decent measure of some kind of physiological utility. Is it something as predictive for choice? Does this work at all as a hedonometer? This kind of measurement tool is due primarily to Danny Kahneman. And I’m going to quickly summarise some results from Angus Deaton from a gallop poll which collects every day from I think 1,000 people a question about how happy are you with your life as of right now. So here is data from Angus’s analysis of gallop poll data. This is for US consumers and what happens is you see changes in happiness. This is the case that there are seniors and everyone is on 2 different graphs here. You see changes in the time of the Lehman Brothers collapse and satisfaction with life went down a little. At the time of the election of President Obama it went down quite a lot. It went up again at the time of the inauguration. And then on April 9th 2009 there was a huge change in life satisfaction. And you look for events in the world that might be associated with that. Nothing, nothing went on that you could explain this. So what was going on? Well it turns out that in the gallop poll people were asked some political questions. How satisfied are you with the politicians you’re dealing with? What happened was that these dates here, here and here are all associated with changes in the political questions. And in particular this huge increase in life, stated life satisfaction came because people were not... The question about satisfaction with the political process was dropped as the immediate preceding question. So what’s the story? There is a signal of real information about pleasure or happiness in these data. But it’s totally buried with a noise caused by the effects of context. So let me conclude in my remaining zero minutes. Einstein said: “Make things as simple as possible, but not simpler.” Now neoclassical consumer theory does track the general association of pleasure and choice but even if you add sociality and some of the other things that really should be in there, it’s still too simple to mimic what really goes on in the brain chemistry and structure that actually drives some of the fine structure of choice behaviour. And it’s also much too static to capture the sensitivity to dynamics and process that are present in truth and choice. In terms of the Kahneman type scales for experience, felicity or life satisfaction, they do approximate what Edgeworth was looking for. They are a kind of a hedonometer. However they’re far too sensitive to context and format in their current incarnation to reliably define consumer welfare response to economic policy. This is basically a statement directed to the British government which is collecting these data and using them to try to assess economic policy changes in Great Britain. Not a good idea right now. Welfare economics based on more neurological measures of utility and brain function is coming. There is clearly a physiological basis which is not all that different than what Bentham originally had in mind, it’s more complicated. But we’re not there yet. What seems to be a kind of a crude hedonometer is still not one that’s functional for welfare analysis. Wait for it, even better, get involved in these lines of research that bridge between economics and other disciplines. And play a role in making this come true. Thank you. Applause.

Daniel L. McFadden (2014)

The New Science of Pleasure

Daniel L. McFadden (2014)

The New Science of Pleasure

Abstract

At the base of economic analysis is the consumer, whose behavior and well-being motivate a whole gamut of questions spanning demand analysis, incentive theory and mechanism design, project evaluation, and the introduction and marketing of private and public goods and services. Understanding and modeling consumer welfare was central in early economics, and remains so, with a continuing tension between elements of illusion, temperament, and subjectivity in consumer behavior, and the need for stable, predictive indicators for demand and well-being. The neoclassical model of the individualistic utility-maximizing consumer that forms the basis of most economic analysis is largely a finished subject, but new studies of consumer behavior and interesting new measurements are coming into economics from cognitive psychology, sociology, anthropology, market science, evolutionary biology, and neurology. This behavioral revaluation challenges the neoclassical conclusion that unconcentrated self-organized markets place consumers on a welfare frontier, and suggests new directions for the continuing development of consumer theory. This talk gives a broad, brief survey of behavioral consumer theory, and places its findings in the context of the early writings of economists on the science of pleasure.

Reference: D. McFadden, “The New Science of Pleasure”, NBER Working Paper No. 18687, February 2013, forthcoming in Handbook of Choice Modelling, S. Hess and A. J. Daly, (eds.), Edward Elgar, 2014.

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