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Bounded Rationality – Definition

Bounded Rationality Definition

Bounded rationality is the opinion that when people make decisions, their rationality is up to the adaptability of the decision-making problem, the logical limitation of their mind and the available time for decision making.

A Little More on Bounded Rationality

Decision makers, satisfiers, in this context are seeking satisfactory solution on the contrary to an optimal solution. Bounded rationality was proposed by Herbert A. Simon as an option of mathematical modelling of decision making as applied in economics, political science and other relative disciplines. It completes rationality as an optimisation which looks at decision making as a fully cognitive process of getting an excellent option given the availability of information. Simon used resemblance of a pair of scissors in which one blade represents cognitive limitations of actual humans and the other blade representing the environmental structure describing how mind pays back for scarce resources by exploiting the known environment structural regularity.

Some human behaviour models on social sciences assume that humans can be reasonably described as logical entities. There are assumptions of people are on average rational by many economist models and can in large amount be estimated to perform according to their preference. The bounded rationality concept revises the assumption to justify that accurate, rational decisions are often not possible in practice due to indocility of natural decision problems and the countable computational resources available for making them.

Origins

Herbert developed the bounded rationality term. Simon outlined, in man’s model, that, most people are partially rational and irrational in the remaining part of their activities. He states in another work that boundedly rational agents experience limitation in developing and solving the complex and in processing information. Simon described some aspects along with the classical model of rationality can be more practical and realistic while holding within the topic of fairly rigorous formalisation. These include;

  1.              Limiting the utility function type.
  2.             I recognize the information gathering, and processing costs as

iii.            The possibility of having a vector or multi-valued utility function.

Simon gave out a suggestion that economic agents use a heuristic to make decisions rather than a strict rule of optimization. This is done because of the situation complexity in addition to their inability to process and calculate the expected satisfaction of available options. Cost of deliberations might be high, and other supplementary economic activities are also requiring decisions to be made.

Relationship to behavioral economics

Bounded rationality suggests the opinion that there are reasoning shortcuts taken by humans and this has the possibility of resulting in suboptimality in the decision making. Behavioural economists did decision shortcuts used by agents to increase the effectiveness of human decision making. For instance, Cass Sunstein and Richard Thaler’s Nudge recommended modification of the architecture choice in regards to the light of human’s agents bounded rationality. They also urged for the positioning of healthier food at sight level to increase the probability of a person opting for the healthier choice rather than less healthy one. Some opposed Nudge attacked him that by architecture modification, people will be worse decision makers.

Influence on social network structure

The previous study showed that individuals bounded rationality may have influence in the social network topology that develops among them. Kasthurirathna and Piraveenan showed the socioeconomic systems, a motivator towards improved rationality on average might be the emergence of scale-free properties developing reason. This was done by simulation of number of strategic games on a random network with distributed bounded rationality after which they rewire the network to averagely cover towards Nash equilibria regardless of bounded rationality nodes. Re-wiring was observed to result in scale-free networks that are omnipresent in the social system. Explaining the social phenomena is based on the link between bounded rationality distributions and social structure.

References for Bounded Rationality

Academic Research on Bounded Rationality

  • Bounded rationality in macroeconomics: The Arne Ryde memorial lectures, Sargent, T. J. (1993). OUP Catalogue. This examination of bounded rationality, a theoretical macroeconomic area, is receiving increased attention. The author is a leading macroeconomist who highlights the involved issues while describing used analytic tools and shows their applicability in various models. It gives probable positive theory development together some of its setbacks.
  • Inductive reasoning and bounded rationality, Arthur, W. B. (1994). The American economic review, 84(2), 406-411. The paper states the types of rationality that are assumed in economics to be perfect, logical, deductive rationality which more essential in developing solutions to theoretical challenges but there is more demand to human behaviour for it to be productive. The paper highlights the two reasons for deductive rationality in breaking down under complication. The first reason is that past a specific complexity level, human logical capacity stops coping hence bounding human rationality. The second one is that in complicated interactive situations, agents cannot rely on peer agents they are dealing with to behave under perfect rationality resulting to behaviour guess producing to continuous subjective beliefs and loss of real belief resulting to inapplicability of deductive rationality.
  • Theories of bounded rationality, Simon, H. A. (1972). Decision and organisation, 1(1), 161-176. The paper the intertwinement that has occurred between decision making in economics and rationality on the other side, the notion of rationality has dominated neoclassical literature. The paper outlines the rationality types to be perfect rationality featured by consistency and maximisation hypothesis assumption. Simon questioned the perfect rationality concept, and he brought out different vision suggestion based on the empiric evidence and individual option. The paper emphasizes the Simon’s bounded rationality since it remains a unique characteristic of his theoretical contribution. There is an examination of the economic decision process in the neoclassical theory and the bounded rationality of Simon by the paper followed by model choice rational behavior and finally suggests assessment of bounded rationality concept.
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  • Bounded rationality and organizational learning, Simon, H. A. (1991). Organization Science, 2(1), 125-134. The paper puts focus on ways of information acquisition and transmission from one part of an entity to another. Understanding of mechanisms in allowing an organisation to deviate from the culture in which it operates, in a culturally deviant organisation, there is a comparison between the ways information are acquired and how they are acquired in organisations that grow in a culture of a society that provides it to new members. The discussion also includes obvious assimilation problem or have to be transmitted from one point to another for use.
  • Maps of bounded rationality: Psychology for behavioural economics, Kahneman, D. (2003). Maps of bounded rationality: Psychology for behavioural economics. American economic review, 93(5), 1449-1475. The paper is about the exploration of the psychology of intuitive belief and choices and the bounded rationality that Simon had proposed that decision-makers should be seen as boundedly rational and he offered a model in which satisfaction replaced utility maximization. In the research, they attempted in obtaining a map of bounded responsibility by examining system biases that separate people belief and their choices from optimal beliefs and choices assumed in rational-agent models.
  • Rational decision making in business organizations, Simon, H. A. (1979). The American economic review, 69(4), 493-513. The author states that the behavioural theory predecessor is the tradition of institutionalism. Institutions use a lot of their language based in law that and seek using transaction as their basic unit of behaviour. The book states that if there is rationality in human decision makers as their limited computational abilities and their unsatisfactory information permit them to be then, there will be a close relationship between normative and descriptive decision theory.
  • Bounded rationality, Simon, H. A. (1990). In Utility and probability (pp. 15-18). Palgrave Macmillan, London. The author stated the designation in the used of bounded rationality in the rational choice that puts a cognitive limitation of the decision maker of knowledge and computational capacity into considerations. In a behavioural approach to economics, bounded rationality is of the central topic that is deeply concerned with the ways of which actual decision-making processes impacts the made decisions.
  • Bounded rationality in individual decision making, Camerer, C. (1998). Experimental Economics, 1(2), 163-183. This paper’s main objectives are; provision of the meaningful, opinionated overview on learned ideas regarding bounded rationality in individual decision making from examination economics and psychology, and promising new directions for research which would be included in the final chapter would be included.
  • Judgment in managerial decision making, Bazerman, M. H., & Moore, D. A. (2008). The paper states the considerable development of behavioural decision examination in the past 25 years and provides a significant view of managerial behaviour. Bazerman & Moore’s Judgment in Managerial Decision Making, 7th edition included behavioural examination into the realm of the organisation by examination of judgments in various managerial backgrounds. The book contains information essential for anyone searching for information on improving judgmental and decision making capability. Many hands-on decision activities and examples from the authors’ pervasive executive training experience in improving the quality of managerial judgment.
  • Why bounded rationality?, Conlisk, J. (1996). Journal of economic literature, 34(2), 669-700. The author study states four reasons for including bounded rationality in economic models namely; first, the existence of much empirical evidence that is significant. Second, the bounded rationality has proved themselves in a wide range of compelling work, thirdly, the standard reasoning for bounded rationality assumption is unconvincing gas their reasoning cuts both ways and finally, the deliberations concerning economic activities is a costly undertaking and good economies require all costs entertainment.
  • Fast and frugal heuristics: The tools of bounded rationality, Gigerenzer, G. (2004). Blackwell handbook of judgment and decision making, 62, 88. The paper examines the cognitive heuristics which is how judgments and decisions are made in everyday life without calculation of probabilities and utilities. Heuristic thinking was integral as the analytical thinking for problems that cannot be solved by calculus or probability theory. The uncertainty of not awareness of optimal solutions to most problems and this also holds less for well-structured problems. When optimal solutions are unreachable, there is no paralysis in action to doom, or failure heuristics can be useful in the decision discovery.
  • Designing economic agents that act like human agents: A behavioural approach to bounded rationality, Arthur, W. B. (1991). The American Economic Review, 81(2), 353-359. The paper talks of possibilities of a unique agent creation with the ability to produce different behaviours and an examination of behaviour have been undertaken through an empirical survey which puts consideration on individual differences; it is possible to input different coefficient in the model. There are sophisticated multi-level approaches allowing agent development that can simulate human behaviour by considering individual variations in the model. These multilevel models in existence can describe many details and relationship among constructs in addition to designing dynamics of behaviour.

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