Bounded rationality 1

Bounded rationalityBounded rationality is the idea that in decision-making, rationality of individuals is limited by the information theyhave, the cognitive limitations of their minds, and the finite amount of time they have to make a decision. It wasproposed by Herbert A. Simon as an alternative basis for the mathematical modeling of decision making, as used ineconomics and related disciplines; it complements rationality as optimization, which views decision-making as afully rational process of finding an optimal choice given the information available.[1] Another way to look atbounded rationality is that, because decision-makers lack the ability and resources to arrive at the optimal solution,they instead apply their rationality only after having greatly simplified the choices available. Thus thedecision-maker is a satisficer, one seeking a satisfactory solution rather than the optimal one.[2] Simon used theanalogy of a pair of scissors, where one blade is the "cognitive limitations" of actual humans and the other the"structures of the environment"; minds with limited cognitive resources can thus be successful by exploitingpre-existing structure and regularity in the environment.[1]

Some models of human behavior in the social sciences assume that humans can be reasonably approximated ordescribed as "rational" entities (see for example rational choice theory). Many economics models assume that peopleare on average rational, and can in large enough quantities be approximated to act according to their preferences. Theconcept of bounded rationality revises this assumption to account for the fact that perfectly rational decisions areoften not feasible in practice because of the finite computational resources available for making them.

Models of bounded rationalityThe term is thought to have been coined by Herbert A. Simon. In Models of Man, Simon points out that most peopleare only partly rational, and are emotional/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" (Williamson, p.553, citing Simon). Simon describes anumber of dimensions along which "classical" models of rationality can be made somewhat more realistic, whilesticking within the vein of fairly rigorous formalization. These include: limiting what sorts of utility functions there might be. recognizing the costs of gathering and processing information. the possibility of having a "vector" or "multi-valued" utility function.Simon suggests that economic agents employ the use of heuristics to make decisions rather than a strict rigid rule ofoptimization. They do this because of the complexity of the situation, and their inability to process and compute theexpected utility of every alternative action. Deliberation costs might be high and there are often other concurrenteconomic activities also requiring decisions.Daniel Kahneman proposes bounded rationality as a model to overcome some of the limitations of the rational-agentmodels in economic literature.As decision makers have to make decisions about how and when to decide, Ariel Rubinstein proposed to modelbounded rationality [3] by explicitly specifying decision-making procedures. This puts the study of decisionprocedures on the research agenda.Gerd Gigerenzer argues that most decision theorists who have discussed bounded rationality have not really followedSimon's ideas about it. Rather, they have either considered how people's decisions might be made sub-optimal by thelimitations of human rationality, or have constructed elaborate optimising models of how people might cope withtheir inability to optimize. Gigerenzer instead proposes to examine simple alternatives to a full rationality analysis asa mechanism for decision-making, and he and his colleagues have shown that such simple heuristics frequently leadto better decisions than the theoretically optimal procedure.

Bounded rationality 2

From a computational point of view, decision procedures can be encoded in algorithms and heuristics. Edward Tsangargues that the effective rationality of an agent is determined by its computational intelligence. Everything else beingequal, an agent that has better algorithms and heuristics could make "more rational" (more optimal) decisions thanone that has poorer heuristics and algorithms.

Notes[1] Gigerenzer, Gerd; Selten, Reinhard (2002). Bounded Rationality: The Adaptive Toolbox (http:/ / books. google. com/

?id=dVMq5UoYS3YC& dq="bounded+ rationality"& printsec=frontcover). MIT Press. ISBN0-262-57164-1. .[2] "Bounded rationality: Definition from Answers.com" (http:/ / www. answers. com/ topic/ bounded-rationality). Answers Corporation. .

Retrieved 2009-04-12.[3] http:/ / arielrubinstein. tau. ac. il/ book-br. html

References Elster, Jon (1983). Sour Grapes: Studies in the Subversion of Rationality. Cambridge, UK: Cambridge University

Press. ISBN0-521-25230-X. Gigerenzer, Gerd; Selten, Reinhard (2002). Bounded Rationality. Cambridge: MIT Press. ISBN0-262-57164-1. Hayek, F.A (1948) Individualism and Economic order Kahneman, Daniel (2003). "Maps of bounded rationality: psychology for behavioral economics". The American

Economic Review 93 (5): 144975. doi:10.1257/000282803322655392. March, James G. (1994). A Primer on Decision Making: How Decisions Happen. New York: The Free Press.

ISBN0-02-920035-0. Rubinstein, Ariel (1998). Modeling bounded rationality. MIT Press. ISBN0-585-05347-2. Simon, Herbert (1957). "A Behavioral Model of Rational Choice", in Models of Man, Social and Rational:

Mathematical Essays on Rational Human Behavior in a Social Setting. New York: Wiley. Simon, Herbert (1990). "A mechanism for social selection and successful altruism". Science 250 (4988): 16658.

doi:10.1126/science.2270480. PMID2270480. Simon, Herbert (1991). "Bounded Rationality and Organizational Learning". Organization Science 2 (1):

125134. doi:10.1287/orsc.2.1.125. Tisdell, Clem (1996). Bounded Rationality and Economic Evolution: A Contribution to Decision Making,

Economics, and Management. Cheltenham, UK: Brookfield. ISBN1-85898-352-5. Tsang, E.P.K. (2008). "Computational intelligence determines effective rationality". International Journal on

Automation and Control 5 (1): 636. doi:10.1007/s11633-008-0063-6. Williamson, Oliver E. (1981). "The economics of organization: the transaction cost approach". American Journal

of Sociology 87 (3): 548577 (http:/ / www. polisci. ucsd. edu/ gcox/ 06 Ollie. pdf) (press +)..

External links Mapping Bounded Rationality by Daniel Kahneman (http:/ / choo. fis. utoronto. ca/ FIS/ courses/ lis2149/

kahneman. NobelPrize. pdf) Artificial Intelligence and Economic Theory (http:/ / huwdixon. org/ SurfingEconomics/ chapter7. pdf) chapter 6

of Surfing Economics (http:/ / huwdixon. org/ SurfingEconomics/ index. html) by Huw Dixon.

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