Bounded Rationality

Introduction

• Introduced by Herbert Simon in 1957.
• Alternative to perfect rationality of homo economicus.
• Focuses on rational behavior within cognitive limits.
• Incorporates various disciplines: decision sciences, economics, cognitive- and neuropsychology, biology, physics, computer science, and philosophy.

Homo Economicus and Expected Utility Theory

• Evolution: From Mill’s self-interested agent to Samuelson’s utility-focused agent.
• Expected Utility Theory:
  • Rational agents maximize expected utility.
  • Axioms of Ordering, Archimedean, and Independence.

Axiomatic Departures

• Alternatives to A1 (Ordering): Indecisiveness and non-transitive preferences.
• Alternatives to A2 (Archimedean): Lexicographic preferences.
• Alternatives to A3 (Independence): Loss aversion and other behavioral tweaks.

Procedural Rationality

• Shift from reasoning to decision costs and quality.
• Satisficing: Stopping rule for decision making once an acceptable threshold is met.
• Linear Models: Proper vs. Improper models and their representation in decision-making.
• Cumulative Prospect Theory: Highlights reference dependence, loss aversion, and probability weighting.

Ecological Rationality

• Decision environments influence decision-making strategies.
• Brunswik's Lens Model: Connections between cues and judgments.
• Rational Analysis: Optimal behavior given goals, environment, and computational limits.
• Cultural Adaptation: Societies as adaptive environments.

Better with Bounds

• Small Samples: Cognitive limits influence statistical reasoning.
• Game Theory: The evolution of cooperation via bounded rationality.
• All Rationality is Bounded: Thermodynamics and the physical limits of computation.

Two Schools of Heuristics

• Biases and Heuristics: Originates from Kahneman & Tversky.
• Fast and Frugal Heuristics: Gigerenzer’s perspective emphasizing simplicity and effectiveness.

Aumann's Five Arguments

1. Agents are not deliberate maximizers.
2. Maximization is typically difficult.
3. People fail to meet rational decision theory assumptions.
4. Rational analysis yields conclusions mismatched with behavior.
5. Rational analysis can be normatively unreasonable.

Appraising Human Rationality

• Various interpretations of rationality including coherence, substantive, and adaptive notions.
• The perception-cognition gap illustrates differences between high and low-level decision tasks.

Conclusion

• Bounded rationality provides a framework accommodating human cognitive limits.
• Emphasizes the importance of context and process in decision-making.