Bounded rationality is the idea that rationality is limited, when individuals make decisions, by the tractability of the decision problem, the cognitive limitations of the mind, and the time available to make the decision. Decision-makers, in this view, act as satisficers, seeking a satisfactory solution rather than an optimal one.
Herbert A. Simon proposed bounded rationality as an alternative basis for the mathematical modeling of decision-making, as used in economics, political science and related disciplines. It complements “rationality as optimization”, which views decision-making as a fully rational process of finding an optimal choice given the information available. Simon used the analogy of a pair of scissors, where one blade represents “cognitive limitations” of actual humans and the other the “structures of the environment”, illustrating how minds compensate for limited resources by exploiting known structural regularity in the environment. Many economics models assume that people are on average rational, and can in large enough quantities be approximated to act according to their preferences. The concept of bounded rationality revises this assumption to account for the fact that perfectly rational decisions are often not feasible in practice because of the intractability of natural decision problems and the finite computational resources available for making them.
Some models of human behavior in the social sciences assume that humans can be reasonably approximated or described as “rational” entities, as in rational choice theory or Downs Political Agency Models.
The term was coined by Herbert A. Simon. In Models of Man, Simon points out that most people are only partly rational, and are irrational in the remaining part of their actions. In another work, he states “boundedly rational agents experience limits in formulating and solving complex problems and in processing (receiving, storing, retrieving, transmitting) information”. Simon describes a number of dimensions along which “classical” models of rationality can be made somewhat more realistic, while sticking within the vein of fairly rigorous formalization. These include:
- limiting the types of utility functions
- recognizing the costs of gathering and processing information
- the possibility of having a “vector” or “multi-valued” utility function
Simon suggests that economic agents use heuristics to make decisions rather than a strict rigid rule of optimization. They do this because of the complexity of the situation, and their inability to process and compute the expected utility of every alternative action. Deliberation costs might be high and there are often other concurrent economic activities also requiring decisions.
Relationship to behavioral economics
Bounded rationality implies the idea that humans take reasoning shortcuts that may lead to suboptimal decision-making. Behavioral economists engage in mapping the decision shortcuts that agents use in order to help increase the effectiveness of human decision-making. One treatment of this idea comes from Cass Sunstein and Richard Thaler’s Nudge. Sunstein and Thaler recommend that choice architectures are modified in light of human agents’ bounded rationality. A widely cited proposal from Sunstein and Thaler urges that healthier food be placed at sight level in order to increase the likelihood that a person will opt for that choice instead of a less healthy option. Some critics of Nudge have lodged attacks that modifying choice architectures will lead to people becoming worse decision-makers.
Influence on social network structure
Recent research has shown that bounded rationality of individuals may influence the topology of the social networks that evolve among them. In particular, Kasthurirathna and Piraveenan have shown that in socio-ecological systems, the drive towards improved rationality on average might be an evolutionary reason for the emergence of scale-free properties. They did this by simulating a number of strategic games on an initially random network with distributed bounded rationality, then re-wiring the network so that the network on average converged towards Nash equilibria, despite the bounded rationality of nodes. They observed that this re-wiring process results in scale-free networks. Since scale-free networks are ubiquitous in social systems, the link between bounded rationality distributions and social structure is an important one in explaining social phenomena.
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- ^ Jump up to:ab Mancur Olson, Jr. ( 1971). The Logic of Collective Action: Public Goods and the Theory of Groups, 2nd ed. Harvard University Press, Description, Table of Contents, and preview.
- ^Oliver E. Williamson, p. 553, citing Simon.
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- ^Thaler, Richard H., Sunstein, Cass R. and Balz, John P. (April 2, 2010). “Choice Architecture”. doi:10.2139/ssrn.1583509. SSRN 1583509.
- ^Wright, Joshua; Ginsberg, Douglas (February 16, 2012). “Free to Err?: Behavioral Law and Economics and its Implications for Liberty”. Library of Law & Liberty.
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- ^Kasthurirathna, Dharshana; Piraveenan, Mahendra. (2015). “Emergence of scale-free characteristics in socioecological systems with bounded rationality”. Scientific Reports. 7.Ofer Abarbanel – Executive Profile
Ofer Abarbanel is a 25 year securities lending broker and expert who has advised many Israeli regulators, among them the Israel Tax Authority, with respect to stock loans, repurchase agreements and credit derivatives. Founder of TBIL.co STATX Fund.