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Matthew Herper, 02.14.06, 12:00 PM ET

Six years ago, Stanford brain scientist Brian Knutson accidentally set
neuroscience and economics on a collision course. Knutson wanted to use MRI
scanners--the same devices used in medical diagnosis--to literally peer
inside people's heads as they experienced intense emotions. He tried showing
volunteers pictures of nude and decapitated bodies. But those reactions
paled compared with what happened when he offered people cash.

In 2000, Knutson published the first paper using magnetic resonance imaging
to photograph what goes on in the brain as people deal with money. Within a
year, his findings and others had given birth to a new field called
neuroeconomics. Neuroeconomics seeks to replace the abstract, hyper-rational
creatures that populate tradition economics with real--sometimes
irrational--people. Neuroeconomists use devices, like MRIs, to observe the
behavior of real people buying and selling things.

"You can actually get inside the black box," says Knutson.

His paper gave neuroeconomics its first real surprise finding. Traditional
economics predicts that people should use money to acquire things that might
make them happy. Money--in and of itself--shouldn't make people happy. But
Knutson found more primal forces at work. Offers of cash caused a surge of
dopamine in a tiny piece of neural machinery called the nucleus accumbens--a
structure as ancient as backbones that plays a key role in addiction. The
surge wasn't caused by a wad of cash already in people's back pockets, but
instead by the opportunity to make some easy money.

"It helps explain why people have such bizarre attitudes toward money," says
George Loewenstein, an economist at Carnegie Mellon University. "According
to standard economic theory, money is a means to an end. When you get money,
you shouldn't experience immediate happiness. What all the scanning research
is showing is that people get immediate pleasure and pain from obtaining and
losing money."

Armed with MRI scanners that measure blood flow in the brain and carefully
structured games involving playing cards and real cash, both neuroscientists
and economists have been watching what actually happens when people make
economic decisions. Skeptics say the new field has yet to completely upend
economic theory and merely has delivered many small findings at the edges of
economic theory. Some also complain that the neuroeconomists are placing too
much confidence in simplified economic exchanges that cannot reflect the
complexity of real life.

But the studies are a first step to mapping out how the brain deals with
money. In a study published in Science in December, Caltech economist Colin
Camerer and colleagues asked why people tend to be afraid to invest in stock
markets outside their own country. For Americans, this isn't a big problem,
because the U.S. is such a global economy. But it can be a big problem in
small nations.

"People tend to be way over-invested in their own country's stock," Camerer
says. "If you're in Brazil or Sweden, you're way under-diversified."

The Caltech researchers did an experiment with two decks of red and blue
cards. Volunteers were told one deck was composed of ten red cards and ten
blue cards; another had an unknown mix of red and blue cards. They were told
if they could guess the color of the first card drawn from either deck, they
would get $10. Most people decide to make their guesses about the deck where
they know there's an even mix of red and blue cards.

However, this is one of those odd cases where logic differs from common
sense, because the odds of guessing the color of that first card are 50-50
whether you know the makeup of the deck or not. (It may be a little easier
to see why if you imagine the deck is all one color. You have a 50-50 chance
of guessing that color correctly.) If you're experiencing a bit of cognitive
dissonance here, you're not alone.

Our brains literally rebel against this experiment, and, using their MRI
scanner, Camerer and his colleagues figured out why. A completely different
part of the brain is used to make decisions about the deck where the odds
seem knowable--where the risk can be gauged--unlike decisions about the
ambiguous deck. Thus people, sometimes irrationally, tend to favor markets
where they think they know the risks (say their home country's stock market)
and shy away from places where they don't know the mix.

Camerer and his colleagues went a step further. Using a database of patients
with brain injuries kept by researchers at the University of Iowa, they
found five patients in whom the relevant brain areas had been destroyed by
stroke or other injuries. These people were just as willing to bet on both
decks--an abnormal response that actually matched up with the odds.

Similar kinds of games, always played with real money and often using MRI
scanners, have shed light on economic decision making in ways that seem
difficult to believe. Researchers at the Baylor College of Medicine decided
to look at how people in an economic relationship--like an investor and his
stockbroker or two executives negotiating a deal--decided to trust each
other.

The Baylor researchers gave one volunteer cash and let him give it to a
"trustee." The trustee was given more money and decided how much to give
back to the volunteer. They repeated the exchange several times and found
that they could pinpoint particular areas of the brain that turned on when
the investor thought the trustee was, well, trustworthy.

"What do we know about the biology of trust?" asks Ernst Fehr, a
neuroeconomist at the University of Zurich. "Basically zero. Biologists
didn't know how to measure trust, and now we bring the two disparate worlds
together. That's neuroeconomics. It's as much a contribution to neurobiology
as to economics."

Fehr went a step further with the same experiment, finding volunteers who
were willing to take a blast from a nose spray containing the hormone
oxytocin, which is involved in pregnancy and appears to help facilitate
social bonds. The oxytocin-dosed investors became much more
trusting--perhaps too much so. In fact, some investors continued to give the
trustees cash, even if they were being ripped off.

Other research has sought to measure exactly how employees react to
punishment and reward, why people seem to value money they've earned over
money they're given, and why and how people lie. Marketers have turned to
the new field for insight (see: "In Search Of The Buy Button"), and such
experiments could even shed light on mental illness.

As MRI technology gets better and experiments become more nuanced,
neuroeconomics stands to gain even more steam. Critics complain that any
good neuroscientist could have guessed many of the field's results. Brian
Knutson, who helped get the ball rolling in the first place, takes issue
with that accusation.

"We can see things smaller and faster than ten years ago," he says. "We
couldn't even divine these findings from invasive rat research." He adds,
"It's happening fast."