Limited rationality (English bounded rationality, also restricted rationality) describes a further development of the model of complete or unrestricted rationality originating from behavioral economics and psychology .
Rationality in economics often used as a basic assumption to both the thinking, behavior and actions of economic agents to explain, and the formalization of simplified models and theories allow. Complete or unrestricted rationality requires unlimited cognitive skills, with which all math problems and information can be processed in a fraction of a second and at no cost. In a decision-making problem, behavior is rational when an alternative course of action is chosen that brings the greatest benefit to the decisive individual.
Limited rational behavior describes on the one hand an intention to maximize the utility of an acting individual under certain restrictions. These consist of limited cognitive skills and recourse to heuristics . On the other hand, behavior is also rational to a limited extent when an individual has to weigh up when the costs of obtaining additional information in a decision-making situation exceed the benefits of this gained information and thus have to make a decision under uncertainty . The individual then searches for alternative courses of action until one of them reaches a desired level of benefit ( satisficing ), regardless of whether there are other alternative courses of action that would achieve a higher benefit.
A distinction must be made between limited rationality and the concept of irrationality . Irrationality describes a deliberate violation of reason. In an economic context, irrational behavior can mean, for example, that a beneficial action B is preferred to another action A, even though A would bring more benefit, i.e. A> B would apply.
History and creation
For their research into which forms of restricted rationality can be expected under which conditions, Daniel Kahneman and Vernon L. Smith received the Alfred Nobel Memorial Prize for Economics in 2002 (their long-term colleague Amos Tversky had died at the time of the award and was therefore not equally honored).
Herbert Simon described in 1959 that the theory of completely rational behavior in relation to reality often reaches its limits. In order to predict human behavior in a constantly changing environment, one must not only know what the goals of an individual are (maximizing utility), but also how the individual adapts his behavior to the dynamic environment. Various experiments showed that individuals behave rationally in simple situations, but no longer do so with increasing complexity of the decision-making situation. He attributed these results to limited cognitive skills and the use of heuristics.
With regard to companies , Simon realized that they would not always try to maximize their profits , as rational behavior would suggest. It is not clear whether profit maximization is more long-term or short-term. For example, companies could also try to generate non-monetary profits such as B. To achieve prestige. In addition, says Simon, it could be that companies only want to achieve a profit that is satisficing, but at the same time not the highest possible. A study showed that companies with falling market shares showed a greater interest in growing sales figures than companies whose market share was constant or even increased. One way to increase sales of a product is to lower its price, which would result in lower profit per item sold.
Cognitive Limitations and Heuristics
Because of cognitive limitations, which make it difficult to solve mathematical problems and to process and absorb information quickly , people resort to so-called (judgment) heuristics. Heuristics are simple problem-solving mechanisms or also mental abbreviations that are often based on simple rules. In principle, heuristics are even economically advantageous, provided they lead to rational decisions, since they cost less time and mental effort. However, these heuristics can also lead to distortions of the judgment in a decision-making situation and thus also to incorrect decisions and assessments. Thus, an action that does not maximize utility and was chosen by means of a heuristic is rationally restricted, since either not all available information was taken into account in the choice (mental abbreviation) or not obtained. In both cases, incomplete information is available and in this case one speaks of a decision under uncertainty or risk.
The recognition or recognition heuristic is a model of judgment and decision-making when there is a lack of information. It says that if one object is known and another is not and if the known object correlates positively with the criterion sought, the known object has a higher value with regard to the criterion.
Example: Which city is bigger: Berlin or Bitterfeld?
As a rule, you know Berlin and not the other city. The awareness of the city is positively correlated with its size, so that the recognition heuristic can be applied.
Often true values of the criterion are not accessible, so that one has to rely on a mediator. Given the amount of research funding at a university, the number of publications per year would be a mediator. A mediator must correlate positively with the criterion so that he can draw conclusions about the value of the criterion. In addition, the mediator must correlate with the recognition. This model of ecological rationality is described in more detail in the article by Goldstein and Gigerenzer listed below.
The availability heuristic states that the estimate of the probability of an event depend on representatives of the corresponding event, which the estimator can remember. How easy it is to remember such representatives is determined by the following factors:
- Public visibility: The more often an event is in public, the easier it is to remember it.
- Context of the information: The more often you come into contact with the event (for example through your job), the easier it is to mentally call up representatives.
- Temporal horizon: the closer an event is in the past, the easier it is to remember it.
- Personal experiences: If you yourself were part of an event to be estimated, you estimate the probability of it to be higher.
Example: flood insurance
Taking out flood insurance after flood damage appears very attractive, as the event did not take place far back in the past. The mental availability of floods is very high after such an event. The longer it has been since the flood, the less the desire to take out such insurance.
If one unconsciously falls back on the availability heuristic when assessing the probability of an event, the search for information is often neglected. You rely on your memory, which is influenced by the factors mentioned above. It is then a question of limited rational behavior, since information that is necessary and available to assess the probability of an event is not taken into account.
In classical economic theory , the goal of any action is to maximize the benefits that arise from it. The psychology, however, indicates that the motivation to act from a desire ( english drive ) is emerging. If an individual finds an action that satisfies this urge, the search for further alternative actions is ended. In a decision-making situation, not all alternative courses of action and their consequences are often given, but must first be worked out and calculated with the help of information.
Restricted rationality in competition policy
In every competition procedure (i.e. a procedure in which it is determined whether a market is regulated or not, for example), a competition authority is confronted with the question of how much information is necessary in order to make the most efficient and market-correcting decision possible . Information acquisition and processing costs are incurred ( transaction costs ). Competition policy should be designed efficiently, d. H. Expected welfare losses of a rule and transaction costs of the procedure should be minimized. A per se prohibition (i.e. a simple prohibition of a certain action) would therefore be efficient, since it is associated with lower transaction costs than a case-by-case approach. However, per se bans would be inefficient in some cases, for example in the case of a bundled product offer from a dominant company . A step-by-step investigation practice is recommended in competition proceedings in which, for example, information that is easy to obtain, such as market shares, is initially considered. If a reliable and efficient judgment is not yet possible, information, the procurement and processing costs of which are higher, are used in the decision-making process. In such a case, there would be limited rationality because, due to information costs, not all information is obtained and taken into account, but an action that is as rational as possible (setting up an optimal rule) should be performed.
- New Institutional Economics
- Free market economy
- Perfect market
- Market psychology
- Social economy
- Recognition heuristic
- Post-factual politics
- Herbert A. Simon: Theories of decision making in economics and behavioral science. In: American Economic Review . Vol. 49, no. 3, 1959, pp. 253-283.
- Gerd Gigerenzer , Peter M. Todd & The ABC Research Group (Eds.): Simple heuristics that make us smart. New York: Oxford University Press, New York 1999, ISBN 0-19-514381-7 .
- Gerd Gigerenzer & Reinhard Selten (eds.): Bounded Rationality: The Adaptive Toolbox. MIT Press, Cambridge / London 2001, ISBN 0-262-57164-1 .
- Daniel G. Goldstein & Gerd Gigerenzer: Models of ecological rationality: The recognition heuristic. In: Psychological Review. 109, 2002, pp. 75-90 ( PDF ).
- Hanno Beck: Behavioral Economics - Springer . 2014, p. 1 , doi : 10.1007 / 978-3-658-03367-5 .
- Reinhard Selten: What is Bounded Rationality? In: University of Bonn (ed.): Discussion Paper Series B . B-454. Bonn May 1999, p. 3 .
- Herbert A. Simon: Theories of Decision-Making in Economics and Behavioral Science . In: The American Economics Review . tape 49 , no. 3 , January 1, 1959, p. 258 ff .
- Justus Haucap: Restricted Rationality in the Competition Economy . In: Düsseldorf Institute for Competition Economics (Ed.): DICE Ordnungspolitische Perspektiven . tape 08 . Düsseldorf 2010, p. 2 .
- Herbert A. Simon: Theories of Decision-Making in Economics and Behavioral Science . In: The American Economics Review . tape 49 , no. 3 , January 1, 1959, p. 269 f .
- Herbert A. Simon: Theories of Decision-Making in Economics and Behavioral Science . In: The American Economics Review . tape 49 , no. 3 , January 1, 1959, p. 262 f .
- Ulrich Arnswald: Rationality and irrationality in the sciences . Ed .: Hans-Peter Schütt. VS Verlag, 2011, ISBN 978-3-531-18269-8 , pp. 5 .
- Andrew M. Colman: Dictionary of Psychology. Oxford University Press, 2001
- Herbert A. Simon: Theories of Decision-Making in Economics and Behavioral Science . In: The American Economics Review . tape 49 , no. 3 , January 1, 1959, p. 256 f .
- RM Cyert, JG March: Organizational Structure and Pricing Behavior in an Oligopolistic Market . In: The American Economic Review . tape 45 , no. 1 , January 1, 1955, p. 137 , JSTOR : 1811586 .
- Hanno Beck: Behavioral Economics - Springer . 2014, p. 38 ff ., doi : 10.1007 / 978-3-658-03367-5 .
- Justus Haucap: Restricted Rationality in the Competition Economy . In: Düsseldorf Institute for Competition Economics (Ed.): DICE Ordnungspolitische Perspektiven . tape 08 . Düsseldorf 2010, p. 3 ff .