Conlisk 1996 - Why Bounded Rationality?

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Conlisk, J. (1996). Why bounded rationality?. Journal of economic literature, 34(2), 669-700.

Summary

Bounded rationality is the result of limited cognitive resources. The author argues that one of the central aspects of bounded rationality has to do with deliberation costs. Oftentimes, (see todo:link Simon’s satisficing) it does not make sense to expend the cognitive resources necessary to make a fully rational choice. In this regard, heuristics and bias can represent rational decisions. They are cognitive resource-saving techniques used for making decisions quickly. By using a heuristic, we are freeing up cognitive resources and time resources in exchange for some error. This error is often preferable to the alternatives (depleted cognitive and time resources).

A plethora of examples is given showing how economic theories are wrong and could be better served by integrating bounded rationality. Theories that have successfully done so are considered as well. The author also considers the issue of bounded rationality or rational decision-making due to bounded information using the following anecdote.

“When I walked into a post while watching a bird, my family called it a dumb move. Among economists, however, I could have claimed that, given the spatial distribution of lamp posts, the expected utility of bird watching exceeded the expected disutility of a collision. Ex ante, the post probably was not there, and it is entirely rational to collide with an ex post post. This example illustrates the confounding of rationality issues with information issues. Am I dumb to walk into a post or merely a rational victim of imperfect information?”

Application

Sometimes, the smart choice is to not make a smart choice, or, as Frank Knight was quoted in the paper as saying, “It is evident that the rational thing to do is to be irrational, where deliberation and estimation cost more than they are worth.” It’s important for managers to be able to know when to keep looking and when to just make a decision. Additionally, when considering a “mistake,” it’s worth remembering that perhaps the mistake isn’t the result of irrationality, but could very well be the result of poor information.