Bounded Rationality

The term 'bounded rationality' is used to designate rational choice that takes into account the
cognitive limitations of the decision-maker - limitations of both knowledge and computational capacity.

Human beings struggle for rationality, but it is restricted within the limits of their knowledge. The
rational choice is feasible as the bounded set of factors on which the decision is based corresponds to a
closed system of variables. This indicates that decisions can be made without taking into account the
possible results derived from knowledge biases.

An action is consciously rational insofar as the adjustment of the means to the ends is a conscious
process. This resembles what economic man (homo economicus) represents, since it has characteristics
such as being fully informed, sensitive and rational. An economic man according to the theory of the
decision, has complete information, assuming that he knows not only all the courses of action, but also his
results. It is sensitive to the available alternatives. The crucial fact about the economic man is that he is
rational. This means that their preferences are complete, transitive and that there are perfect substitutes;
and on the other hand he makes his decisions to maximize his utility.

The Theory of the instrumental rationality or rational choice, assumes that, in a situation of
decision, the means, the information, the beliefs and personal analyzes, are optimal; the estimates of
probabilities are easily realizable; the individual has at his disposal information about all possible
alternatives and has a complete and consistent system of preferences that allows him to make a perfect
analysis of all of them. It does not present difficulties or limits in the mathematical calculations that it
must carry out to determine which the best is, therefore, it guarantees that the chosen alternative is a
global optimum.

The theory of bounded rationality, sees the decision process from a very different point of view.
In the decision-making process, even in relatively simple problems, a maximum cannot be obtained since
it is impossible to verify all possible alternatives. People differ in both available opportunities and desires
(influenced by environmental factors). When an individual must decide, they influence him, both the
desires that he possesses and the opportunities that he thinks he has. It is not certain that these beliefs are
correct: it is possible that the individual is not aware of some opportunities that are actually viable to him
or, he may believe that certain opportunities are favorable to him, which in reality are not, therefore it
cannot be guaranteed that he choose the best alternative.

Human behavior is rational first intention, but bounded by information asymmetry. And as
mentioned earlier, the ability of the human mind to formulate and solve problems is small and is bounded
by neuropsychological issues on the one hand and language limits on the other. Physical limits are the
individual abilities to receive, retrieve and process information; those of language refer to the inability of
individuals to articulate their knowledge or feeling by the use of a word, so that they can be understood
by others.

Theories of bounded rationality can be generated by relaxing one or more of the assumptions of
rational choice theory. Instead of assuming a fixed set of alternatives among which the decision-maker
chooses, we may postulate a process for generating alternatives. Instead of assuming the maximization of
a utility function, we may postulate a satisfying strategy. The particular deviations from the assumptions
of global maximization introduced by behaviourally oriented economists are derived from what is known,
empirically, about human thought and choice processes, and especially what is known about the limits of
human cognitive capacity for discovering alternatives, computing their consequences under certainty or
uncertainty, and making comparisons among them.

GENERATION OF ALTERNATIVES

Modern cognitive psychology has studied in considerable depth not only the processes that
human subjects use to choose among given alternatives, but also the processes (problem-solving
processes) they use to find possible courses of action (i.e., actions that will solve a problem). If we look at
the time allocations of economic actors, say business executives, we find that perhaps the largest fraction
of decision making time is spent in searching for possible courses of action and evaluating them (i.e.,
estimating their consequences). Much less time and effort is spent in making final choices, once the
alternatives have been generated and their consequences examined. The lengthy and crucial processes of
generating alternatives, which include all the processes that we ordinarily designate by the word 'design',
are left out of the economic choice theory. Study of the processes for generating alternatives quickly
reveals that under most circumstances it is not reasonable to talk about finding 'all the alternatives'.
The generation of alternatives is a lengthy and costly process, and one where, in real-world
situations, even minimal completeness can seldom be guaranteed. Theories of optimal search can cast
some light on such processes, but, because of limits on complexity, human alternative-generating
behaviour observed in the laboratory is usually best described as heuristic search aimed at finding
satisfactory alternatives, or alternatives that represent an improvement over those previously available.

EVALUATION OF CONSEQUENCES

Cognitive limits, in this case lack of knowledge and limited ability to forecast the future, also
play a central role in the evaluation of alternatives. These cognitive difficulties are seen clearly in
decisions that are taken on a national scale: whether to go ahead with the construction of a supersonic
transport; the measures to be taken to deal with acid rain; Federal Reserve policies on interest rates; and,
of course, the supremely fateful decisions of war and peace.
The cognitive limits are not simply limits on specific information. They are almost always also
limits on the adequacy of the scientific theories that can be used to predict the relevant phenomena. For
example, available theories of atmospheric chemistry and meteorology leave very wide bands of
uncertainty in estimating the environmental or health consequences of given quantities and distributions
of air pollutants. Similarly, the accuracy of predictions of the economy by computer models is severely
limited by lack of knowledge about fundamental economic mechanisms represented in the models'
equations.

CRITERIA OF CHOICE

The assumption of a utility function postulates a consistency of human choice that is not always
evidenced in reality. The assumption of maximization may also place a heavy (often unbearable)
computational burden on the decision maker. A theory of bounded rationality seeks to identify, in theory
and in actual behaviour, procedures for choosing that are computationally simpler, and that can account
for observed inconsistencies in human choice patterns.

Comparison between Bounded Rationality and Rational Choice

Bounded rationality Rational choice

Necessity of assistance of the bounded mental Unbounded cognitive ability of the subject who
capacity of the subject that decides. decides.

Knowledge of an acceptable set of actions Knowledge of all available actions.

Approximate and heterogeneous knowledge of the Numerical knowledge of all the consequences of
consequences. actions.

Evolutionary and unsettled preferences. Stable and ordered preferences.

Temporary and cost limitation that affects the Unbounded or non-influential resources in the
quality of the decision. decision-making process.

Search for a satisfactory result Search for the best possible result

Help the one who decides to understand what will Inform the one who decides about what to do.
happen if he does something.