Every day, we are confronted with advertisement enticing us into buying some new amazing product: Imagine you needed a new laptop and that when you scrolled down this blog post, a flashing ad popped up promoting an extreme price drop on a laptop. How would you decide whether to buy it?
Purchase decisions are complex. Typically, we weigh the positive characteristics of the product against its costs and then decide whether to purchase it. Supported by behavioral data, economic theories have aimed at explaining how humans make purchase decisions for a long time. Since recently, technical developments such as functional Magnetic Resonance Imaging (fMRI) have allowed us to measure the metabolic demands of active neuronal cells. These techniques can help us understand how the brain functions even in non-clinical contexts, such as which brain regions are involved in purchase decisions.
What happens in our brain when we make purchase decisions?
One of the first studies showing which specific brain regions are involved in purchasing was conducted by Brian Knutson and colleagues in 2006. Here, subjects decided whether to buy different products such as a chocolate bar while lying in an MRI scanner. The authors found that when subjects thought about buying a product they liked (that is, before the actual decision), the nucleus accumbens was activated, a region associated with anticipating reward. In contrast, when subjects were confronted with excessive prices, the insula was activated, a region commonly known for anticipating losses. Further, when the product had a reduced price, the medial prefrontal cortex was involved which is usually implicated in integrating gains and losses. Not only could the authors link specific brain regions to the negative and positive characteristics of a product (price and product preference), but they could also predict the subjects’ purchase decisions based on these brain activations. Specifically, they showed that the higher the activity in the nucleus accumbens and the lower the activity in the insula, the more likely did the subjects buy a product. Thus, the authors found specific neural circuits which support purchasing decisions and are associated with the emotional state before the actual decision.
In their study, Knutson and colleagues viewed the price and preference as independent characteristics of a product. However, you might wonder, does the price of a product not affect how much (or little) we like it? Indeed, this relationship and its neural representations had remained unclear – until Hilke Plassmann’s study 12 years ago.
Would you like some $90 Cabernet Sauvignon?
Hilke Plassmann and her colleagues investigated whether the price of a product influences the pleasure we experience when consuming it. Until then, economics had assumed that experienced pleasantness only depends on the state of the consumer and the intrinsic properties of the product (see also this article). To find out whether the price would affect the experienced pleasantness of a product, Plassmann and her colleagues had subjects taste wines while scanning them using fMRI. The subjects were told that there were five Cabernet Sauvignons being sold at different prices, namely from $10 to $90. They believed that the study purpose was to investigate the effects of degustation time on flavors. However, this was only a cover story: In fact, the researchers gave them only three different wines two of which were presented twice, namely for $10 and $90, respectively. What the researchers found was that increasing the wine price increased not only the subjective reports of flavor pleasantness but also the response in a brain region called the medial orbitofrontal cortex. Interestingly, other studies showed that this region encodes experienced pleasantness. Thus, Plassmann showed that price manipulation influences our preference of a product not only on a behavioral level (that is, how much we say we like it), but also on a neural level (via the medial orbitofrontal cortex). Generally, this study gave one of the first clues for the neural basis of how marketing actions such as pricing influence how much we enjoy products.
Imagine you want to buy something to drink in the supermarket. Let’s assume you could choose between Coca-Cola and Pepsi – sorry, no $90 Cabernet Sauvignon this time. Which one would you take? Almost certainly, you would not pick one by chance. Probably, you would rather use your past experiences with these two brands to decide which one to buy.
Coca-Cola or Pepsi?
Samuel M. McClure and his colleagues investigated how brand image influences people’s behavioral choices and their brain responses. Here, comparing Coca-Cola and Pepsi is particularly interesting because even though both have rather similar chemical compositions, people usually strongly prefer one over the other. To investigate the influences of brand image on preference, the authors scanned subjects using fMRI and had them taste the drinks either with or without brand labels. What they found is that brand information has a strong influence on the subjects’ preference, especially in the case of Coca-Cola. Here, subjects preferred the drink significantly more in brand-labelled cups than they did in the anonymous condition. Moreover, brand knowledge of Coca-Cola involved responses in the brain regions such as the hippocampus and the dorsolateral prefrontal cortex. Other studies showed that the latter is involved in employing affective information to bias behavior. This fits to the context of McClure’s study, namely in that the dorsolateral prefrontal cortex was involved when the labelled Coca-Cola biased subjects’ behavior. Additionally, the activity of the hippocampus is related to recalling cultural information that biases preference judgments; cultural information such as the image of a brand. Thus, using behavioral and neural data, McClure and colleagues could show the influence of brand information on product preference, especially with Coca-Cola, and which brain regions were involved in this influence.
All the studies summarized above involve findings important for the newly emerging field of Neuroeconomics. You have never heard of it? No worries, it has developed only in the beginning of the 21st century. In this field, the ideas from psychology, neuroscience and economics are integrated and benefit from each other, thereby modeling economic choices and decisions. Economists and psychologists provide the conceptual means for understanding and modeling economic decision-making, whereas neuroscientists have the tools to study the specific mechanisms behind it (for more information, see also Glimcher, Sanfey and Mohr).
From the supermarket to the stock market
These neuroscientific tools are not only useful to shed light on the neural underpinnings of purchase decisions but also more complex financial contexts such as stock decisions. As Cary Frydman and Colin F. Camerer pointed out, economists have identified many behavioral patterns in how individual investors trade stocks. As an example, the realization utility hypothesis states that investors “derive utility from realizing gains and losses on assets that they own” (see also Barberis and Xiong). That is to say that they directly obtain value (or utility) by the act of selling a winning stock while they obtain disutility by selling a losing stock. However, the cognitive mechanisms behind such patterns had remained unresolved when only looking at the behavioral level. Going beyond this approach, Cary Frydman and colleagues tested the realization utility hypothesis by combining behavioral and neural data. In their study, subjects traded stocks in an experimental market while fMRI data was acquired. Interestingly, each subject traded in a suboptimal way, namely by showing the so-called disposition effect. The latter means that subjects were more likely to sell stocks at risen value rather than fallen value since purchase. On a neural level, the researchers found that the realization of capital gain is positively correlated with activity in the ventral striatum. The latter is one of the key brain structures in reward processing and known for encoding information about changes in expected lifetime utility. Thus, Cary Frydman and her colleagues could find support for the realization utility model by combining neural and behavioral data.
Do you still remember the nucleus accumbens and the insula in the purchase decision experiment from the beginning of this blog post? Just as a little reminder, the nucleus accumbens and the insula encoded the anticipation of reward and losses, respectively. These very same brain regions also play a key role in a study by Alec Smith and colleagues. Using multisubject fMRI, they investigated the neural basis for the development of price bubbles in an experimental market. In their study, the price bubbles always resulted in a crash and were caused by the interactions between the different trading types of subjects, namely naïve backward-looking investors, fundamental traders, and sophisticated forward-looking investors. When subjects had elevated activity in the nucleus accumbens, which encodes higher anticipation of reward, their future returns were actually low and a crash more likely. Thus, this brain activity served as a general indicator for price bubbles and explains some of the euphoria and irrational exuberance often encountered close to price bubble peaks. Moreover, when activity in the insula was higher, trading performance and selling were positively correlated. Hence, activity in the insula, which signals anticipated losses, could provide an early warning signal to switch from risky to risk-free assets. Thus, Smith and his colleagues found behavioral and neural support for those price bubble theories that are based on interacting traders with exuberant valuation and forward-looking traders riding bubbles and selling when feeling uncertain.
To put it in a nutshell
Neuroscientific methods can serve as powerful tools to shed light on economic theories from a new perspective. Using these tools, researchers have contributed much to the understanding of economic processes, from daily life purchase decisions to stock trading behavior in price bubbles.
A short overview of the key learnings
- Don’t let higher prices seduce you and your medial orbitofrontal cortex into preferring a certain wine more than you would without its price tag.
- Be suspicious about your hippocampus and dorsolateral prefrontal cortex when drinking Coca-Cola – they might trick you into liking it more than you would without knowing the brand.
- Enjoy selling a winning stock and don’t let your ventral striatum miss out.
- Be cautious when your insula is signaling you excessive prices – especially when trading stock in price bubbles.