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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 due to the finite computational resources available for making them.

The term is thought to have been coined by Herbert Simon. In Models of My Life, Herbert Simon points out that most people are only partly rational, and are in fact 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 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 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 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 economic activities where similar decision making is required.

Daniel Kahneman proposes bounded rationality as a model to overcome some of the limitations of the rational-agent models in economic literature.

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 argues that most decision theorists who have discussed bounded rationality have not really followed Simon's ideas about it. Rather, they have either considered how people's decisions might be made sub-optimal by the limitations of human rationality, or have constructed elaborate optimising models of how people might cope with their inability to optimize. Gigerenzer instead proposes to examine simple alternatives to a full rationality analysis as a mechanism for decision making, and he and his colleagues have shown that such simple heuristics frequently lead to better decisions than the theoretically optimal procedure.

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.

A school of economic thought that traditionally assumes that economic agents have bounded rationality is the Austrian school.

References

• Jon Elster (1983). Sour Grapes: Studies in the Subversion of Rationality. Cambridge, UK: Cambridge University Press.
• Gigerenzer, G. & Selten, R. (2002). Bounded Rationality.Cambridge: The MIT Press; reprint edition. 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). pp. 1449-1475
• March, James G. (1994). A Primer on Decision Making: How Decisions Happen. New York: The Free Press.
• Martin, J.; Knopoff, K. & Beckman, C. (1998). An alternative to bureaucratic impersonality and emotion labor: Bounded emotionality at The Body Shop. Administrative Science Quarterly, 43, 429-469.
• Mumby, D. K. and Putnam, L. L. (1992). The politics of emotion: A feminist reading of bounded rationality. Academy of Management Review, 17, 465-486.
• Rubinstein, A. (1998). Modeling bounded rationality, MIT Press.
• 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): 1665-1668.
• Simon, Herbert (1991). Bounded Rationality and Organizational Learning, Organization Science 2(1): 125-134.
• Tisdell, Clem (1996). Bounded Rationality and Economic Evolution: A Contribution to Decision Making, Economics, and Management. Cheltenham, UK; Brookfield, Vt.: Edward Elgar.
• Tsang, E.P.K. (2008). Computational intelligence determines effective rationality, International Journal on Automation and Control, Vol.5, No.1, 63-66.
• Williamson, Oliver (1981). The economies of organization: the transaction cost approach. American Journal of Sociology 87(3): 548-577.

See also

• Altruism
• Austrian economics
• Behavioral economics
• Homo economicus
• Irrationality
• Neoclassical economics
• Psychohistory
• Rational choice theory
• Parametric determinism
• Rational ignorance
• Satisficing
• Carnegie School
• Utility maximization problem
• Transaction cost
• Subjective theory of value

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