One of Mark Thoma’s links of the day is beyond awesome.
Experiments in the Brain Scanner
A total of 24 subjects participated in the study which has just been published. Whilst recumbent in a scanner, they were called upon to solve simple problems. Success brought a financial reward. At the same time, as the experiment evolved, the fluctuations in the blood oxygen saturation of diverse areas of their brains were monitored. This reading indicates the degree of activity in the relevant area of the brain. The prize-money was not subsequently paid out in cash, but the successful test subjects were allowed to choose goods from a catalogue – including CDs, sun cream or computer accessories.
“We had now confronted our test subjects with two different situations”, Falk explains. “In the first, they could only earn a relatively small amount of money, but the items in the catalogue were also comparatively cheap. In the second scenario, the wage was 50 per cent higher, but now all the items were 50 per cent more expensive. Thus, in both scenarios the participants could afford exactly the same goods with the money they had earned – the true purchasing power had remained exactly the same.” The test subjects were perfectly aware of this, too – not only did they know both catalogues, but they had been explicitly informed at the start that the true value of the money they earned would always remain the same.
Despite this, an astonishing manifestation emerged: “In the low-wage scenario there was one particular area of the brain which was always significantly less active than in the high-wage scenario”, declares Bernd Weber, focusing on the main result. “In this case, it was the so-called ventro-medial prefrontal cortex – the area which produces the sense of quasi elation associated with pleasurable experiences”. Hence, on the one hand, the study confirmed that this money illusion really exists, and on the other, it revealed the cerebro-physiological processes involved.
Now I personally suffer from a particularly humiliating form of money illusion. I earn and spend in Italy in Euros. The Dollar/Euro exchange rate has essentially no effect on my real wage (well I do spend a week or two a year in the USA). However, I feel richer when the Euro is strong. I automatically convert my salary to dollars even though, by now, I am totally out of touch with the US price level.
Obviously there’s a reason why I’ve never bought into the rational expectations hypothesis. I know that I am very very irrational.