Bounded Rationality PDF

Bounded Rationality  Rationality - a logical, step- by-step approach to decision making, Rational Model with a thorough analysis of alternatives and their consequences 1. The outcome w...

Bounded Rationality  Rationality - a logical, step- by-step approach to decision making, Rational Model with a thorough analysis of alternatives and their consequences 1. The outcome will be completely rational 2. The decision maker uses a consistent system of preferences to choose the best alternative 3. The decision maker is aware of all alternatives 4. The decision maker can calculate the probability of success for each alternative Rational Decision Making Model Identify the problem Establish the decision making criteria Weigh the decision criteria Generate alternatives Evaluate the alternatives Choose the best alternative Implement the decision Evaluate the decision Application of rational Thinking  Your old car has broken down; You decide to buy a new car  STEP 1- Establish the decision making criteria  How many passengers - for 5 passengers  Mileage – 12 km / litre  Safety concerns 1. Passengers 1. Safety  Price - 5 lakhs 2. Safety 2. Passengers  STEP 2 – Weigh the criteria 3. Price 3. Mileage 4. Mileage 4. Price  STEP 3 – Generate alternatives  STEP 4 – Evaluate alternatives 1. Mileage 1. Price 2. Price 2. Mileage  STEP 5 – Choose the best 3. Safety 3. Passengers  STEP 6 – Buy the car 4. Passengers 4. Safety  STEP 7 – Evaluate and note the decision Generating and evaluating alternatives is the most important step in decision making. Use rational thinking in important decision making Factors that limit rational behavior  People do not always behave in rational ways  People are strongly influenced by the outcomes of their past decisions  People will discount information that conflicts with their beliefs or values  People tend to construct decision making rules and follow them even if they are inappropriate in a particular situation  People rationalize their choices From rationality to bounded rationality…  Bounded rationality theory sees people as rational, but limited by the amount of information they have and their ability to quickly process that information (because of time constraint).  Bounded rationality gives us a much more realistic view of how humans actually behave by looking at the ways we don’t (or can’t) act.  Decision-makers, in this view, act as satisficers, seeking a satisfactory solution rather than an optimal one.  Satisfice – to select the first alternative that is “good enough,” because the costs in time and effort are too great to optimize  For example, buying a house? Do you go for optimal solution or satisfied solution?  For example, a manager wanting to fire people from organization but within one hour. Will rational decision i.e. taking a step by step process work here?  Herbert Simon’s Model Proposed in 1976. Decision making is not perfectly rational; it is boundedly rational: Limited information processing (cannot evaluate all potential alternatives in limited time) Satisficing (stop when the solution is “good enough”– pick radio station) Judgmental heuristics  Bounded Rationality - a theory that Bounded Rationality suggests that there are limits upon Model by Herbert Simon how rational a decision maker can actually be Satisfice – to select the first alternative that is “good enough,” because the costs in time and effort are too great to optimize 1. Decision makers suggest the first satisfactory alternative 2. Decision makers recognize that their conception of the world is simple 3. Decision makers are comfortable making decisions without determining all the alternatives 4. Decision makers make decisions by rules of thumb or heuristics Heuristics – shortcuts in decision making that save mental activity