Why Bounded Rationality?

NEARLY EVERYONE would see the truth as between Hamlet and Puck. Including Hamlet and Puck. Hamlet is feigning madness, and Puck is just being, well, puckish. Model-writing economists, however, tend not to the middle but to the “infinite in faculties” extreme. Although the postulate of unbounded rationality has dominated economic modeling for several decades, the dominance is relaxing. Is this encouraging? Why bounded rationality? In this survey, four reasons are given for incorporating bounded rationality in economic models. First, there is abundant empirical evidence that it is important. Second, models of bounded rationality have proved themselves in a wide range of impressive work. Third, the standard justifications for assuming unbounded rationality are unconvincing; their logic cuts both ways. Fourth, deliberation about an economic decision is a costly activity, and good economics requires that we entertain all costs. These four reasons, or categories of reasons, are developed in the following four sections. Deliberation cost will be a recurring theme. Most references are to the last 15 years, though many earlier works are also cited. A longer version of the survey, including many more references, is available from the author on request.