June 2007 Issue
buyerBeware_header.jpg
Issue Home | > Buyer Beware

Buyer Beware

By:

Deciding whether something is worth buying should be a simple, rational decision. Yet, too often, all of us make a purchase that not long afterwards has us asking, "What in the world was I thinking?" George Loewenstein has asked that question, and what his research uncovered may change century-old economic theory.

George Loewenstein's heart quickened when he saw the envelope. "I can't open it here," he thought to himself while standing in the mailroom in the University of Chicago's Graduate School of Business. "It's bad luck." He walked to his office, closed the door behind him, and sat down at his desk.

He was understandably anxious. The contents would either lift a huge weight off his shoulders or pile more on, darkening the shadow he felt creeping across his young career in economics. Loewenstein realized he was just being superstitious by heading to his office, but he had stood in the mailroom when he read the first two letters, so maybe ... well, it couldn't hurt. Besides, if it was to be the third rejection of his research, he didn't like the thought of having to lug that disappointment through the busy hallways trying to avoid his colleagues as he made his way back to his office to collect his thoughts. It was best to be alone.

Loewenstein had been in his position as assistant professor of behavioral science for about two years. But in that time, he hadn't yet grabbed the first brass ring needed not only for rising up the academic ranks toward tenure, but for keeping his job. He hadn't published a paper. And he was starting to feel the pressure.

That's why the letter was so important. It was from the editor of a British publication called Economic Journal. About six months prior, Loewenstein had submitted a research paper on an unconventional topic: Anticipation and the Valuation of Delayed Consumption. It was the first paper he had written as a professor. It had already been rejected twice by two of the most prominent economic journals–first by The Quarterly Journal of Economics, the oldest professional economics journal in the English language, and then by its slightly younger counterpart, American Economic Review. Their brief, dismissive replies basically said, "Sorry, this is not economics." Both times, the news landed like a blow to the stomach and chipped away at his confidence that he would ever be published. To make matters worse, because of the exclusive submit-and-wait process, two years had passed.

The unpublished paper was born from his dissertation on intertemporal choice–the tradeoffs between costs and benefits that occur at different points in time. In other words, how purchasing decisions we make today affect the purchases we can and cannot make tomorrow. For example, if we buy a new laptop today, that's money we won't have to spend on other goods in the future. On the other hand, if we save or invest our money today, the opposite will be true–we'll have more spending options in the future.

Most economists, at the time, relied on the theory of discounted utility (DU) to explain intertemporal choice. ("Utility" is defined by economists as happiness or enjoyment.)

According to the DU model, people are impatient. We want rewards now, and we want to delay unpleasant experiences as long as possible. But Loewenstein's research proved differently. He reintroduced an argument that dated back to 1789 that states that anticipation plays as much of a role in our utility as the actual consumption of a product. In other words, anticipating an outcome–whether positively or negatively–affects our happiness and guides our behavior. That's why, for example, we schedule an appointment for a root canal (an unpleasant experience) sooner rather than later. Or why, instead of taking a vacation right away (a pleasurable experience), we plan several months in advance. The anticipation of such events affects our utility.

Loewenstein fundamentally believed that there was much more going on in consumers' brains than logical, cognitive decision making when choosing what to buy. His thinking went against the grain of conventional economic thought, which espouses that people make decisions based on rationality–logically weighing the expected pros and cons of purchases and then deciding based on what will bring them the greatest utility. But Loewenstein disagreed with that logic. He had noticed too many exceptions to the rational-choice rule in his own behavior, which made him question some of the core beliefs of conventional economic theory.

His concern about the letter from the Economic Journal was not unjustified. The bitter recollection of one particular annual meeting of the American Economic Association remained fresh in his mind. It took place as Loewenstein neared the completion of his PhD, not too many months before he landed a position at the University of Chicago. The conference included a career-placement component, with university recruiters on hand, searching for the best and brightest in the field. While each of his Yale classmates had 15-20 interviews lined up (by invitation only), Loewenstein, whose research didn't exactly align neatly with conventional economics, had just one. Worried about how he was going to earn a living, he decided to check out the nonacademic openings at some of the corporate booths and ended up interviewing with Quaker Oats for a brand manager position. Having always desired to work in academia, he wondered whether he'd wasted four years of his life getting a PhD to sell oatmeal.

Ultimately, he landed a job in academia, but as the unpublished professor sat alone in his office two years later with his unopened letter, his future was far from secure. After he nervously opened the letter and read the publisher's decision, he immediately called his wife to share the news. He would not be unemployed anytime soon. "That was a lifesaver for me," says Loewenstein, now the Herbert A. Simon Professor of Economics and Psychology at Carnegie Mellon. "I still have fond feelings toward the editor of that journal for being so open-minded."

It has been 21 years since Loewenstein opened that letter. He has since published more than 100 papers, edited five books and written one, been an invited speaker 140 times just since 1995, and either authored or coauthored 25 book chapters. Clearly, his work has become more accepted throughout the years, and he is now considered by many of his colleagues to be one of the most influential researchers in his field.

Despite his rise in stature in the academic community, Loewenstein hasn't been complacent. In fact, some of his latest work may turn out to be his most important. It calls into question century-old economic theory. It's certainly grabbing more headlines from mainstream media than anything he published previously.

To understand his latest research, it's important to first comprehend its evolution. In the late 1980s, Loewenstein's papers joined a small but growing body of research that reintroduced psychology into the economic mix. The line of thinking eventually sprouted into behavioral economics, now considered a subset of economics. Mainstream economists, schooled in rational choice, did not necessarily welcome it with open arms. It included feelings, emotions, and impulses–factors that did not fit cleanly in the mathematical formulas they favored. Interestingly, however, Loewenstein discovered that psychology and economics were very much intertwined before the turn of the 20th century. However, the economic community at that time, looking to gain respectability for its burgeoning field, distanced itself from psychology, also just finding its legs as a discipline, because it was considered less "scientific." To Loewenstein, this was a big mistake.

Now Loewenstein has taken behavioral economics a giant step forward by doing what some researchers think is impossible–measuring thoughts and feelings. Using magnetic resonance imaging (MRI) equipment (the same test hospitals use to scan bodies for structural abnormalities such as tumors or strokes), he and his collaborators are scanning people's brains to explore "the most fundamental economic activity"–what goes on inside our heads when we're deciding what to buy. His research with MRI has helped launch the promising new field of neuroeconomics, a combination of neuroscience, psychology, and economics. In the past few years, it has caught the attention of the popular press, including The New York Times, The Economist, and The Wall Street Journal, which have featured Loewenstein's work.

An MRI machine is a large metal box that looks something like a giant porcelain flower vase lying on its side. It includes a sliding gurney that juts out from its narrow, tunnellike mouth. Subjects in Loewenstein's buying choices studies lie face up on the gurney, with a high-tech mask of sorts placed over their heads, and are slid into the machine headfirst. While lying inside, the volunteers view images through the mask in four-second intervals. First they see a college-friendly product such as a USB flash drive; a Napoleon Dynamite DVD; or a waterproof, disposable camera. The product is followed by its price, which is followed by a screen asking them to make a decision. The volunteers, while remaining as still as possible, answer using handheld devices. They are given a $40 credit at the start of testing and are told that if they decided to buy any of the products (at about 75 percent below retail), two of their choices would be randomly given to them at the end of the test and they could keep any leftover change. If they choose not to buy, they pocket 40 bucks.

Throughout the process, the MRI snaps pictures of the brain, registering where the blood and oxygen are flowing, which tells researchers what parts of the brain are active. The end result is a series of high-resolution images that show a detailed outline of the brain in black and grey with colored boxes clumped together representing brain activity at any given point in the test. Using what neuroscience research has already discovered about what roles the different parts of the brain play, neuroeconomists can better understand how the brain processes information and makes decisions.

In Loewenstein's MRI study, with Brian Knutson of Stanford University and Drazen Prelec of the Massachusetts Institute of Technology, he discovered new neuroscientific evidence to support what he had long suspected–parting with money is painful. Different parts of the brain were at work at different stages in the decision-making process. When volunteers were first presented with a product, especially something they found desirable, the nucleus accumbens–a region of the brain known for processing actual and anticipated rewards and pleasures–jumped into action. When the price popped up on the screen, however, two other regions fired up–the insular cortex, associated with the anticipation of pain and monetary loss, and the medial prefrontal cortex, a region associated with rational analysis. Most telling was the direct correlation between the latter two regions when subjects made their decisions. When a price appeared that seemed too steep, the brain's pain processing center (the insular cortex) lit up, while the brain's engine for logical analysis (the medial prefrontal cortex) slowed down. Conversely, when a subject decided to buy a product, the prefrontal cortex was the most active region, suggesting that the brain quickly crunched the numbers and determined that the product was a good purchase. The results were so clear that Loewenstein and his colleagues were able to predict with some reliability whether subjects decided to buy or reject products just by looking at the MRI scans right before volunteers made their decisions. For example, if the insular cortex was active, chances are the subject clicked the "no" button.

Their findings, recently published in Neuron, suggest that there's a battle in the brain between immediate pleasure and immediate pain when we're deciding what to buy. This contradicts conventional economic theory, which states that people make decisions based on immediate pleasure versus saving their buying power for some future pleasure. The subjects in the MRI study weren't thinking about what benefits they would gain at some later date if they chose not to purchase The Family Guy DVD set now. Rather, they were deciding based on how painful (or not) they thought paying for it would be right now.

Loewenstein says that the findings helped confirm what he and Prelec first noticed (i.e., that spending money can be painful) in the early 1990s while collaborating on a paper. At the time, they had to rely on mathematical models to prove their point. But MRI technology now allows them to back up that claim with hard data–real pictures of human brains that show real activity in the brain's pain center. Hard data is what Loewenstein hopes will eventually lead to the acceptance of the field among doubters who still hold fast to traditional economic theory.

Revolutionizing economic thinking was never Loewenstein's agenda, even when he hosted the first-ever conference on neuroeconomics at Carnegie Mellon, which was attended by economists, psychologists, and neuroscientists. Loewenstein's longtime collaborator Colin Camerer, a behavioral economics professor from the California Institute of Technology who helped host the conference, says, "We didn't have any illusions that we were going to look back on this as the beginning of some dramatic new paradigm shift. It was just like, ‘Let's find some interesting people who are studying interesting things that we don't know that much about and get them together.'"

If they didn't shift the paradigm at that 1997 conference, they at least started leaning their shoulders into it, suggests Jonathan Cohen, professor of psychology and director of the Center for the Study of Brain, Mind, and Behavior at Princeton University, who at the time of the conference was an associate professor of psychology at Carnegie Mellon. "There was no question that there was a buzz, and that buzz, one could say, ignited into a whole field ... Whatever claims some may want to lay to having contributed to the beginning of neuroeconomics, if you had to pinpoint the moment in time in which that field first had its manifestation, that was it."

Loewenstein hopes to follow up his research regarding the "pain of paying" by exploring a growing and looming problem in the United States–why so many people run up so much credit card debt. Much like he did in the study with Knutson and Prelec, he wants to see what goes on in the brain when someone pulls out plastic instead of money when making purchases. His hypothesis is that credit cards numb the brain's pain center (i.e., reduce activity in the insular cortex) because no currency is exchanged and costs are postponed, thus weakening the body's built-in defense mechanism against unnecessary purchases. He believes that MRI testing could provide definitive answers.

With all the recognition, Loewenstein says he no longer feels like the outsider as he did in his early days at the University of Chicago. "I'm sure there are [still] a lot of people who don't like what I do," he says, "but there are enough people who do." As for that first paper he wrote, the one that caused him so much anxiety because he was unsure that it would ever be published, it has been cited, according to Google Scholar, nearly 200 times.

Mike Ransdell is a Pittsburgh-based freelance writer.

Back to Top ^

TalkBack

Leave a comment about the story

Comments are moderated and will be published at the moderator's discretion.

Thank you for your comment it has been submited for review.

Linda S.

Good article on the "pain of paying". However, if a person is on pain medication will that effect the nucleus accumbens and/or the insular cortex so that they spend more? Most research uses students and low income people. Has this study included a balance of age and social-economic diversity with equal results? Sorry 2 sound cynical, but what are some future possible benefits for mankind from this research?

Becky Folger -Texas

This study leaves me excited!!I have long tried to reveal this truth to my children of "emotional economics".Your findings should be REQUIRED; beginning with every high school freshman curriculum,continuing through the senior year. The negative effects on society from uneducated spending and happenstance saving is visible in our "boomer" generation. My daughter attends C.M.U. now. My son in high school will definitely read this article and we will discuss it. It could very well save his future! Thank you, Sincerely

Michael C. Hanna

Very interesting andalysis with the use of amedical device and the empirical evidence of functionality in certain regions of the brain. I suppose the question for business is how to win the fight in the decision with the value proposition.

louis detoro IA71

man can be an irrational thinker;thus man can act(buy or sell)irrationally.u.wis. madison phil. chair gives a "thumbs up"...200 yrs. of econ. can be wrong

louis detoro

my new book,"EEK!!!onomics..."points out that immorality is irrational. consider behavior such as the seven deadly sins,or cheating,or lying.think of goods and services and greed,lust,envy, or sloth,etc. louis detoro(IA71)

louis detoro(IA71)

How about group decision-making and irrationality,e.g. poisoning the environment?

louis detoro(IA71)

Are products that are unhealthy necesssarily irrational? How about illegal products? For example, evaluate the use of cigarretttes,alcohol,marijuana,pain killers, cocaine, or heroine.

louis detoro

how much of why we buy is "want" or "need",how much is successful marketing , and how much is "lust"(irrationality)?

louis detoro

depending upon the mix of factors that effect demand,Di1 may be Di2,even if Pi1=Pi2 (D is demand,P is price,and-owing to other factors ,demand curves are different,e.g. taste)