Bounded Rationality

Business, Legal & Accounting Glossary

Definition: Bounded Rationality

Full Definition of Bounded Rationality

Bounded rationality is a branch of economic theory about decision making. It was first proposed by behaviourist Herbert Simon in 1957. As per Simon, decision making by economic agents is a type of search process, which is guided by an agent’s aspiration levels. Aspiration level in its turn is that value of a particular goal variable, which must be attained or even surpassed by any satisfactory decision alternative. (For instance, in the theory of firms market shares and profit can be termed as goal variables). Economic agents are not provided with decision alternatives. They actually find them out. Aspiration levels are also not fixed permanently. They are dynamic in nature (being adjusted as per situation). Aspiration levels are raised (lowered) if satisfactory alternatives are easy (difficult) to find.

Simon’s original bounded rationality proposition possess the following three main concepts.

  • Search for alternatives
  • Aspiration adaptation
  • ‘Satisficing’

It is assumed that definite cognitive limits exist regarding knowledge of economic agents (like consumers and manufacturers). [A fully rational individual (economic agent) is nearly impossible to find in reality as full rationality demands presence of unlimited cognitive abilities]. In that case, these economic agents can act rationally up to a certain limit only. In other words, the rationality of these economic agents is bounded. Hence as a corollary, economic agents often end up accepting solutions, which are ‘good enough’ within an indifference zone. Here instead of seeking optimal solutions economic agents just ‘satisfice’.

The economic literature on bounded reality comprises two main types. One in that case where economic theorists start with optimal behaviour models and proceeds by levying new types of restrictions or constraints on economic decision-maker(s). In the second case entirely new models of economic analysis are developed on alternative principles (distinct from those of optimal behaviour models).

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Definition Sources

Definitions for Bounded Rationality are sourced/syndicated and enhanced from:

  • A Dictionary of Economics (Oxford Quick Reference)
  • Oxford Dictionary Of Accounting
  • Oxford Dictionary Of Business & Management

This glossary post was last updated: 28th March, 2020 | 6 Views.