# Bounded rationality

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Bounded rationality is the idea that in decision-making, rationality of individuals is limited by the information they have, the cognitive limitations of their minds, and the finite amount of time they have to make a decision. It was proposed by Herbert A. Simon as an alternative basis for the mathematical modeling of decision making, as used in economics 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.[1] Another way to look at bounded 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 the decision-maker is a satisficer, one seeking a satisfactory solution rather than the optimal one.[2] Simon used the analogy 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 exploiting pre-existing structure and regularity in the environment.[1]

Some models of human behavior in the social sciences assume that humans can be reasonably approximated or described as "rational" entities (see for example rational choice theory). 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 finite computational resources available for making them.

## Origins

The term is thought to have been coined by Herbert A. Simon. In Models of Man, Simon points out that most people are 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".[3] 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
• 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.

## Model Extensions

As decision makers have to make decisions about how and when to decide, Ariel Rubinstein proposed to model-bounded rationality by explicitly specifying decision-making procedures. This puts the study of decision procedures on the research agenda.

Gerd Gigerenzer opines that decision theorists have not really adhered to Simon's original ideas. Rather, they have considered how decisions may be crippled by limitations to rationality, or have modeled how people might cope with their inability to optimize. Gigerenzer proposes and shows that simple heuristics often lead to better decisions than theoretically optimal procedures.

Huw Dixon later argues that it may not be necessary to analyze in detail the process of reasoning underlying bounded rationality.[4] If we believe that agents will choose an action that gets them "close" to the optimum, then we can use the notion of epsilon-optimization, that means you choose your actions so that the payoff is within epsilon of the optimum. If we define the optimum (best possible) payoff as $U^*$, then the set of epsilon-optimizing options S(ε) can be defined as all those options s such that:

$U(s) \geq U^*-\epsilon$.

The notion of strict rationality is then a special case (ε=0). The advantage of this approach is that it avoids having to specify in detail the process of reasoning, but rather simply assumes that whatever the process is, it is good enough to get near to the optimum.

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

## Notes

1. ^ a b Gigerenzer, Gerd; Selten, Reinhard (2002). Bounded Rationality: The Adaptive Toolbox. MIT Press. ISBN 0-262-57164-1.
2. ^ "Bounded rationality: Definition from Answers.com". Answers Corporation. Retrieved 2009-04-12.
3. ^ Oliver E. Williamson, p. 553, citing Simon.
4. ^ Moss; Rae, eds. (1992). "Some Thoughts on Artificial Intelligence and Economic Theory". Artificial Intelligence and Economic Analysis. Edward Elgar. pp. 131–154. ISBN 185278685X.

## References

• Elster, Jon (1983). Sour Grapes: Studies in the Subversion of Rationality. Cambridge, UK: Cambridge University Press. ISBN 0-521-25230-X.
• Gigerenzer, Gerd and Selten, Reinhard (2002). Bounded Rationality. Cambridge: MIT Press. ISBN 0-262-57164-1.
• 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): 1449–75. doi:10.1257/000282803322655392.
• March, James G. (1994). A Primer on Decision Making: How Decisions Happen. New York: The Free Press. ISBN 0-02-920035-0.
• Rubinstein, Ariel (1998). Modeling bounded rationality. MIT Press. ISBN 0-585-05347-2.
• 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): 1665–8. doi:10.1126/science.2270480. PMID 2270480.
• Simon, Herbert (1991). "Bounded Rationality and Organizational Learning". Organization Science 2 (1): 125–134. 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. ISBN 1-85898-352-5.
• Tsang, E.P.K. (2008). "Computational intelligence determines effective rationality". International Journal on Automation and Control 5 (1): 63–6. 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): 548–577 (press +).