What is Bounded Rationality?

According to the Stanford Encyclopedia of Philosophy, Bounded Rationality refers to “a wide range of descriptive, normative, and prescriptive accounts of effective behavior which depart from the assumptions of perfect rationality.” Many investors with bounded rationality tendencies often attempt to satisfy themselves rather than optimize their choices from a more significant and long-term perspective. Simply put, they choose a decision considered decent enough rather than the best possible one.

Bounded Rationality Examples

According to Profit.Co, a general example of bounded rationality is “when emotions and other prejudices influence people.” For example, one can get influenced by economic biases rather than natural logic when making decisions. This will cause happy people to make risky decisions rather than somewhat agitated people. Consequently, people will make substandard decisions, which can impact their investment or organization in the short and long term.

Another instance in which bounded rationality occurs is when people encounter complex problems, such as choosing the most suitable investment strategy. Since there is a plethora of information needed to judge, it becomes significantly more challenging for people to make the right choices.

Effects of Bounded Rationality

According to The Decision Lab, bounded rationality can “cause us to make decisions that satisfy us in the short-term, either because we are biased by immediate gratification, or because we do not have the capacity or time to calculate the long-term costs of our decisions.”

However, due to individual cognitive constraints, it is hard to assess numerous information varieties to make a rational decision properly. This, in turn, makes one choose insufficient decisions. Although these decisions may be rational regarding the limited information one realistically looks at, they may not be sensible about the broad and diverse range of accessible information in the world.

Although it is hard to adhere to perfect sound economic and behavioral tendencies, bounded rationality causes individuals to make decisions inconsistent with their ideal goals. This is also prominent in organizations that emphasize proper financial decision-making principles. Still, they often overlook that the individuals that make these decisions have irrational economic tendencies since they are influenced by factors other than pure logic. This can lead companies to make satisfactory decisions rather than the ones best for their short- and long-term futures. Therefore, the rationality of decision-makers in companies is constrained by the expectation to prioritize the company’s interests over their own.

Bounded Rationality Importance

Bounded rationality is significant because it helps individuals understand the limitations of rational decision-making. It highlights how individuals often face certain constraints, including limited information, time, and cognitive abilities, when making choices.
By understanding bounded rationality, we can further comprehend why people may not always make perfectly rational decisions.
Bounded rationality can be used to underline the limitations of individuals and organizations when analyzing numerous variables of information during a decision-making process.
Bounded rationality prompts one to make good enough decisions rather than impeccable ones.
While one can relatively control bounded rationality, it can consequently prompt them to analyze decisions logically, which can further benefit themselves or their organizations in the short and long term.

Conclusion

Overall, bounded rationality emphasizes the importance of considering cognitive restrictions and the realities of decision-making in numerous situations and contexts. We can strive for more realistic and practical decision-making approaches by acknowledging and understanding these limitations.