The concept of bounded rationality proposes that when people make decisions, they face limits on their rationality stemming from their available information, cognitive capabilities, and time constraints. This idea was first put forth in 1957 by the influential behavioral scientist Herbert Simon.
According to Simon, people do not have access to complete information nor unlimited mental faculties to always make optimal choices. Instead, decision-making involves a search process guided by aspiration levels – the minimum satisfactory value of a particular goal variable like profit or market share. People must discover available alternatives rather than being presented with all options.
Moreover, aspiration levels are fluid rather than fixed, adjusting based on the difficulty of the search process. If suitable options are abundant, aspirations rise. If few alternatives meet needs, expectations lower.
Simon argued that economic actors like consumers and businesses exhibit bounded rationality. Their knowledge is restricted, so rationality has limits. This means people often settle for “good enough” solutions that meet a minimum threshold rather than continuing to search indefinitely for elusive optimal answers. Satisficing replaces maximizing.
Later scholars expanded on Simon’s original ideas. Some imposed more constraints on theoretical fully rational models to better reflect reality. Others developed completely new frameworks based on principles other than optimization. But the key insight around the inherent bounds of human decision-making remains influential.
The concept of bounded rationality suggests rationality has situational limits rather than an idealized absolute form. This perspective better explains the outcomes of real-world decision-making processes.
What is bounded rationality?
Bounded rationality is the idea that when individuals make decisions, their rationality is limited by the information they have, the cognitive limitations of their minds, and the finite time they have to make a decision.
- Individuals face constraints on time, knowledge, and mental capacity that prevent them from making perfectly rational decisions.
- Rather than finding optimal solutions, people seek solutions that are “good enough” or satisfactory. This is known as “satisficing.”
- Decisions are made using heuristics, simple rules of thumb that provide adequate but often imperfect solutions.
- Individual rationality is limited by the situational context rather than true perfect rationality.
- A shopper needs to buy eggs at the grocery store. Rather than researching all the different egg brands, the shopper picks a carton labeled “cage-free” because that satisfies their need for ethical eggs. The shopper relies on the “cage-free” heuristic without further optimization.
- A manager needs to decide between two software systems. Rather than carefully scoring each option, they simply choose the system used by a colleague at another firm. The referral serves as a limited but satisfactory heuristic.
- An investor needs to pick stocks but does not have the time or capacity to analyze the entire market. They pick a few well-known companies in industries they are familiar with. This provides a “good enough” solution based on limited information.
Bounded rationality explains why individuals often make imperfect real-world decisions rather than perfectly logical choices. Businesses must account for satisficing behaviors rather than presuming pure rationality. Strategies that simplify choices and rely on heuristics cater to bounded rationality. However, over-simplification can also lead to poor choices, so balancing appropriate heuristics with education is ideal.