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Cognitive Abilities and Economic Preferences

English title Cognitive Abilities and Economic Preferences
Applicant Goette Lorenz
Number 124676
Funding scheme Project funding (Div. I-III)
Research institution Dépt d'économétrie et économie politique Faculté des Hautes Etudes Commerciales (HEC) Université de Lausanne
Institution of higher education University of Geneva - GE
Main discipline Economics
Start/End 01.09.2009 - 31.08.2011
Approved amount 234'434.00
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Keywords (7)

Economic Preferences; Cognitive Abilities; Experiments; cognitive abilties; risk preferences; time preferences; social preferences

Lay Summary (English)

Lead
Lay summary
Tradeoffs are the essence of economics. In many cases, considering these tradeoffs is cognitively demanding. For example, evaluating tradeoff over time requires an individual to imagine what the future may hold. Investment in a risky asset entails understanding how a low payoff from the asset could be cushioned and how that would affect utility. Reacting to choices others have made requires assigning them motives. Economists have largely assumed that individuals use perfect cognition to make these tradeoffs. Imperfect cognition, it has been argued, will lead to unsystematic errors and can therefore be ignored. However, evidence shows that this is not the case: Individuals with better cognitive abilities have been shown to be more patient, more willing to take calculated risks, and more inclined to adhere to norms of reciprocity. These results raise two questions:(1) Do individual differences in cognitive ability cause differences in preferences? The previous studies report an association between cognitive and economic preferences, but that cognitive abilities cause differences in preferences cannot be shown. Only exogenously induced variation in cognitive ability can address this question. (2) Through which channel does cognitive ability affect preferences? Cognitive abilities can affect preferences because smarter individuals may be better able to control their impulses or through because smarter people are better able to think through options. The current studies are unable to distinguish between the two. In this research project, we propose to use recent advances from research in psychology to address these questions. Several previous papers show that large gains in IQ can be achieved by a specific form of memory training. We will apply this training in varying intensity to 250 subjects over a period of two months. This provides us with exogenous variation in cognitive abilities. Variation in the intensity of memory training will provide us with gradual, exogenous variation in IQ. We can then examine, within individuals, how this changes patience, risk aversion, and social preferences.The design of this project allows us to estimate the causal effect of IQ on preferences. It has applications in many areas, from better understanding how limited cognition affects choices in general, to providing guidance for education policies.
Direct link to Lay Summary Last update: 21.02.2013

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Abstract

Tradeoffs are the essence of economics. In many cases, considering these tradeoffs is cognitively demanding. For example, evaluating intertemporal tradeoffs requires an individual to imagine what the future may hold. Investment in a risky asset entails understanding how, e.g., a low payoff from the asset could be cushioned and how that would affect utility. Economists have largely assumed that individuals have perfect cognition to make these tradeoffs. Imperfect cognition, it has been argued, will lead to unsystematic deviations in behavior relative to the optimum and can therefore be ignored. However, evidence exists that this is not the case: Individuals with better cognitive abilities have been shown to be more patient, more willing to take calculated risks, and more inclined to adhere to norms of reciprocity (Benjamin et al., 2006; Burks et al., 2008; Dohmen et al., 2007; Frederick, 2005). These results raise two questions: 1) Do individual differences in cognitive ability cause differences in preferences? The previous studies report correlations, and causality cannot be established. Only exogenously induced variation in cognitive ability can address this question. 2) Through which channel does cognitive ability affect preferences? Cognitive abilities can affect preferences through better impulse control or through enhanced information processing. The current studies are unable to distinguish between the two. Adequate measurement, combined with exogenous variation in cognitive abilities, can resolve this issue.In this research project, we propose to use recent advances from research in psychology to address these questions. In a breakthrough paper, Jaeggi et al. (2008) show that large gains in IQ can be achieved by a specific form of memory training (see Sternberg, 2008, for an appraisal of their discovery) We will apply this training in varying intensity to 250 subjects over a period of two months. This provides us with exogenous variation in cognitive abilities. We will measure each subject’s IQ, information processing capabilities, and economic preferences at three points in time: immediately before, immediately after, and six months after the memory training sequence. - Variation in the intensity of memory training will provide us with gradual, exogenous variation in IQ. We can then examine, within individuals, how this changes patience, risk aversion, and reciprocity. - We will also measure information processing capabilities separately, using appropriate tasks as described below, to address the question of information processing vs. impulse control. - We will retest the individuals six months after the study to examine how long-lasting the treatment effects are. The design of this project allows us to estimate the causal effect of IQ on preferences. It has applications in many areas, from establishing stylized facts that may be captured by models of limited cognition to providing guidance for education policies.
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