What is economic rationality?

What is a good introduction to bounded rationality?

  • The leading paradigm in economic theory assumes that economic agents (households, firms) are perfectly rational in making their decisions. Experimental evidence and common sense indicate that this assumption is often too demanding. Alternatively one can consider models of "bounded" rationality, where agents violate full rationality but behave in accordance with experimental evidence. Source of description: http://studiegids.uva.nl/web/uva/sgs/nl/c/2619.html#

  • Answer:

    Ariel Rubinstein has written a book entitled "Modeling Bounded Rationality", and his publisher has allowed him to post a PDF of the entire book on his website: http://gametheory.tau.ac.il/el/getPDF.asp?Pfile=br.pdf. A good Intro to the idea and it's uses would be the work of Herbert Simon, i'd start with "Models of Man" for a background, but Rubinstein's work is more fleshed out (plus, he gives you formulas)

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I recommend Max Bazerman's book: Judgement in managerial decision-making and Daniel Kahneman's book: Thinking fast and slow. If you are interested behavioral rationality applied to finance, you might like this to start: http://www.nber.org/papers/w9222.pdf  A SURVEY OF BEHAVIORAL FINANCE Nicholas Barberis Richard Thaler

Eli Kass

Gerd Gigerenzer and Richard Selten have complied a book with chapters from a number of different researchers.  It's called Bounded Rationality.  The Adaptive Toolbox. The book emphasizes the notion that the concept of bounded rationality as it is traditionally applied (adjusting a few standard assumptions) breaks down when examined closely.  The high level argument is that, when people can only attend to some information, and when attention has cost (e.g. in time opportunity cost) then people must decide what to attend to.  This optimization problem iterates on itself and is unsolvable.  Thus, the "boundedly rational" solution to a problem given cognitive constraints cannot be derived by the decision makes subject to those bounds.  Thus  the acceptance of "bounded cognition" logically contradicts "bounded rationality" in large systems.  Heuristics -- simple decision rules that are "more often right than wrong" become an avenue for exploration to replace the traditional notions of bounded rationality. However, the most common use of the term -- adjusting models to account for a few specific, somewhat predictable behaviors is still useful from a theoretical perspective, in a similar way to how the economic models that assume rationality.  They provide an interesting abstraction, and a way to look as certain pure relationships.  It's important, though, to realize that these are still large abstraction.

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