Bounded Rationality and Behavioural Economics

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Simon then gets into some rather esoteric mathematics and formulae based on those elements. Big math aside, as I see it, he was putting forth a theory of outcomes-based thinking — in the s! Again, this strikes me as recognition of the kind of due diligence with regard to relational contracting and the Vested sourcing business model that is only now being recognised and adopted.

1. Homo Economicus and Expected Utility Theory

Simon set the course and some precepts for rationality in decision-making that are as valid and thought-provoking today as they were when he first developed them. This is the same kind of bridge that is needed today between business people that are seeking to outsource, and their lawyers and stakeholders. They will then be able to create sustainable outsourcing deals that are both fair and flexible in nature as "business happens". Vitasek is known for her practical and research-based advice for driving transformation and innovation through highly-collaborative and strategic partnerships.

The term was coined by Herbert A. In Models of Man , Simon points out that most people are only partly rational, and are irrational in the remaining part of their actions.

Bounded Rationality, Satisficing and the Evolution of Economic Thought - AgEcon Search

In another work, he states "boundedly rational agents experience limits in formulating and solving complex problems and in processing receiving, storing, retrieving, transmitting information ". These include:. 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.

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.

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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.

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.

Bounded Rationality and Behavioural Economics

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. Because of this expansion of the bounds of rationality, machine automated decision making makes markets more efficient.

Bounded rationality implies the idea that humans take reasoning shortcuts that may lead to suboptimal decision-making.

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Behavioral economists engage in mapping the decision shortcuts that agents use in order to help increase the effectiveness of human decision-making. A widely cited proposal from Sunstein and Thaler urges that healthier food be placed at sight level in order to increase the likelihood that a person will opt for that choice instead of a less healthy option.

Some critics of Nudge have lodged attacks that modifying choice architectures will lead to people becoming worse decision-makers. Recent research has shown that bounded rationality of individuals may influence the topology of the social networks that evolve among them. In particular, Kasthurirathna and Piraveenan [12] have shown that in socio-ecological systems, the drive towards improved rationality on average might be an evolutionary reason for the emergence of scale-free properties.

What is ‘bounded rationality’?

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