Herbert Simon is a pioneer in the study of limited rationality. The scientist made a truly invaluable contribution to science and received the Nobel Prize in economics in 1987. What is the concept of limited rationality?
What is the essence
To begin with, in order to understand the meaning of the model of limited rationality, you can simply reproduce the shopping process in your head. On average, a person goes around a couple of stores in order to compare prices, but usually not more than three or four. Why waste time? And it is unlikely that you will begin to study in depth the assortment in stores across the country to find out all the possible offers. But you could save a lot during your analysis! To summarize what has been said, this results in limited rationality. That is, a person’s tendency to make decisions based on the study of only a small part of the information received. Simon's concept of limited rationality entailed a lot of useful research. We will briefly talk about them below.
The concept of limited rationality
Many social sciences define human behavior as rational. For example, the theory of rational choice tells us about this . Some hypotheses suggest that people are hyperrational. This means that they never do anything that could harm their interests. And here, in contrast, the concept of limited rationality is put forward, which just refutes these allegations and states that in fact, absolutely reasonable decisions are practically impracticable. Why? Due to the limited computing resources that are required to make these very decisions. The term "limited rationality", as mentioned above, was proposed by Herbert Simon, who devoted a book to the study entitled "Models of my life." The scientist writes that many people act rationally only in part - they are usually emotional and irrational. Another work of the researcher tells us that, with limited rationality in decision-making, an individual experiences problems with the formulation and calculation of complex problems, as well as with the processing, obtaining, and use of various kinds of information.
What can be complemented by the classical model of rationality
Simon cited examples of such directions in which the model of rationality is supplemented by those factors that are more consistent with reality, while not deviating from the boundaries of strict formalism. The principles of limited rationality are as follows:
- Limitations associated with utility functions.
- Analysis and accounting of the price of collection and processing of information received.
- The possibility of manifestation of the vector utility function.
In his research, Herbert Simon suggested that economic agents use heuristic analysis and not specific rules for optimizing decisions. This is primarily due to the fact that difficulties may arise in assessing the situation and calculating the usefulness of each action.
What follows from this
The famous scientist Richard Thaler put forward a theory directly related to limited rationality - about mental accounting. This concept will determine the process of accounting for income and spending in the human mind. Mental accounting is a multidimensional definition. Here scientists include the tendency of people to create targeted savings. This means that a person prefers to keep his savings in several banks, and most often these are ordinary glass containers, rather than financial institutions, as one might think. It is also worth noting that a person will calmly lower his hand into the piggy bank, where an insignificant amount is stored than in the next box with larger savings.
Social preferences
The economic game invented by scientists also helps to understand the theory of limited rationality, which has an unusual name: “Dictator”. Its essence is extremely simple, even a child can cope with the task. One participant becomes a dictator and distributes the resources received to honey by himself and another player. A dictator can easily leave all his capital to himself, but, as practice shows, most players still share with their opponent. Studies have shown that, on average, a dictator allocates about 28.4% of all resources to his adversary. This game vividly demonstrates some inconsistency of the most common economic models: a rational and selfish person would no doubt take all the resources to himself without sharing with others. That is, the “Dictator” proves to us that the adoption of economic decisions depends on such an important category as justice. Thus, the study showed that justice is important not only for a specific person, but also for the entire economy.
How it is proved in practice
A simple and relevant example can be given. Companies that raise prices for building materials in areas where a natural disaster occurs are absolutely rational in terms of classical economic theory. However, in reality there is a huge risk of falling under a wave of aggressive criticism, which will result in serious public pressure. But here it is impossible to predict the reaction to 100%. It all depends on how the company management explains its actions. If they justify the increase in prices in high demand, then storms of discontent on the part of society cannot be avoided. But if we are talking about increased costs, then buyers in most cases relate to the increase in the cost of products with understanding, because this already sounds fair. Which is very important for making economic decisions.
What about problems with self-control
Probably, in the life of almost every third person, it happened that he absolutely definitely decided to go on a diet, but then somehow unexpectedly ended up at 12 in the open refrigerator. Or he decided to start getting up earlier in the mornings in order to have time to do more in a day, but in the end he opened his eyes only at eleven - and again half the day down the drain ... Is that familiar? Such actions have an economic explanation. Richard Thaler suggested that in such cases we are controlled not by a rational “planner”, but by a lazy “leader”. It is also worth noting that at the level of intuition, a person feels this contradiction between the planner and the figure living inside. It is for this reason that there is always a demand for things that provide self-control. Such goods include alarms that run from their owner or “eat up” a banknote left in advance if they are not turned off. This human need is inherent in virtually everyone, and manufacturers make good money on it.