Bounded Rationality (Behavioural Economics)

Bounded rationality is the idea that the cognitive, decision-making capacity of humans cannot be fully rational because of a number of limits that we face.

These limits include:

• Information failure – there may be not enough information, or it may be unreliable, or maybe not all possibilities or consequences have been considered
• The amount of time that we have to make our decisions
• The limits of the human brain to process every piece of information and consider ever possibility

The result is that we usually end up making satisficing decisions, rather than optimizing decisions. To make decision, we end up using “rules of thumb” or heuristics. Sometimes we rely on automatized routine too.

The impact of bounded rationality is that contracts cannot be fully complete in order to cover all possibilities, and this suggests that markets rarely work perfectly.

Behavioural economists generally point out that bounded rationality is not the same as irrationality, because decision-makers are still attempting to make as rational a decision as possible.