Licchavi Lyceum


Licchavi Lyceum

What is bounded rationality? What role does it play in decision making?

Bounded rationality is a concept in behavioral economics and decision-making theory developed by Nobel laureate Herbert A. Simon. It suggests that individuals, when making decisions, are not always perfectly rational due to cognitive limitations, information constraints, and time constraints. Instead, they operate within “bounded” or limited rationality.

Key aspects of bounded rationality:

  1. Limited Information: In many real-world situations, individuals do not have access to complete and perfect information. They have to make decisions based on the information that is available to them, which may be incomplete, uncertain, or ambiguous.
  2. Cognitive Constraints: Human cognitive abilities are finite, and individuals have limited capacity to process and analyze information. Complex decisions often require simplifications and heuristics (rules of thumb) to make them manageable.
  3. Time Constraints: Decision-making often occurs under time pressure. In such cases, individuals may not have the luxury of conducting extensive research or considering all possible alternatives and consequences.
  4. Satisficing: Bounded rationality leads to a concept known as “satisficing,” where individuals aim to find a solution that is satisfactory or “good enough” rather than searching for the optimal or best possible solution. They settle for an option that meets their minimum criteria, even if it may not be the absolute best choice.
  5. Heuristics: People often rely on mental shortcuts or heuristics to simplify decision-making. These heuristics are rules of thumb or decision rules that are based on experience and intuition. While they can be efficient, heuristics can also lead to biases and errors.
  6. Context and Framing: Bounded rationality acknowledges that decision-making is influenced by the way choices are presented or framed. People may make different decisions based on how information is presented to them, even if the underlying problem remains the same.

The role of bounded rationality in decision-making:

  1. Adaptive Behavior: Bounded rationality is a recognition of the adaptive nature of human decision-making. It acknowledges that individuals must make choices and decisions in a world with constraints, and they do so by adapting to those constraints.
  2. Efficiency: Bounded rationality can be seen as an efficient way to navigate a complex world. It allows individuals to make reasonably good decisions in a timely manner, even when faced with limited information and cognitive resources.
  3. Risk and Uncertainty: Bounded rationality acknowledges that individuals may not always make fully rational decisions, especially in situations involving risk and uncertainty. It helps explain why people may rely on rules of thumb or make choices that deviate from traditional economic models of rationality.
  4. Behavioral Economics: Bounded rationality has contributed significantly to the field of behavioral economics, which studies how psychological and cognitive factors influence economic decisions. Researchers in this field study the ways in which bounded rationality can lead to deviations from the predictions of classical economics.

In summary, bounded rationality recognizes that human decision-making is constrained by cognitive limitations, limited information, and time pressures. While it may lead to decisions that are less than perfectly rational, it is a practical and adaptive approach to decision-making in the real world. Understanding bounded rationality helps researchers and policymakers better understand and predict human behavior in various contexts.