Bounded rationality is a term first coined by Herbert Simon. Simon challenged the concept of a rational man in classical and neoclassical economic theories and argued that the rationality of man is bounded by certain limitations. He opined that even though rational thinking, deductive reasoning and logic are good for solving theoretical problems.
They are not so good for practical problem solving where the behavior of the decision-maker and his intellect, information about the problem at hand and the time to solve such a problem may create a scenario where the decision-making may happen under a rationality that is bounded by certain conditions. He argued that in real situations people take decisions on the basis of heuristics rather than rule based optimization methods. He argued that decision-making is bounded by the following limitations.
We’ll be covering the following topics in this tutorial:
Lack of information or incomplete information leads to sub optimal decisions as the decision-maker is not fully aware of the pros and cons of a decision due to lack of information. Hence, lack of information creates a boundary and hinders the rational choice of the decision-maker.
Intellectual Ability/Cognitive Ability
The problem at hand may be so complex that the decision-maker may not be able to comprehend the true nature and complexity of the problem, leading to a sub optimal decision. If the problem would have been comprehensible, the decision-maker would have made a rational choice. This creates a boundary on the otherwise rational choice of the decision-maker.
Lack of Time to take Decisions
The lack of time may also lead to suboptimal decisions as in this case the decision-maker does not have time to evaluate all the choices and come to a rational choice. On the contrary, lack of time leads to improper and sub optimal decisions, as one does not have the required time to process the information available.