Bounded Rationality: Why You Make Weird, Dumb Decisions

Bounded rationality is a concept in behavioral economics and decision theory. It describes the limitations of human decision-making. Unlike the assumption in traditional economics that individuals are fully rational, bounded rationality recognizes biological constraints. In other words, traditional economics studies a perfectly rational, logical human being that makes optimal choices, whereas bounded rationality takes into account limited information, cognitive biases, time pressure, and mental capacity. These constraints result in “satisficing” decisions. Choices that are good enough. Not choices that are perfect or optimal.

The concept suggests that humans are incapable of processing all available information. Hence bounded rationality. This is due to cognitive limitations. Brains are strong, fast biological supercomputers. But even these machines have limited memory and processing power. We call these cognitive limitations. For instance, when buying a car, we might concentrate on price, fuel efficiency, and brand reputation. Yet we will not analyze every feature or research every available model. Processing every piece of information would simply be impractical and exhausting.

Time is another significant factor in decision-making. Under pressure, individuals rely on rules of thumb to make quicker decisions. Even if these shortcuts lead to suboptimal outcomes—they often do. For instance, in a busy supermarket, a shopper may choose the brand they recognize and move on in lieu of doing a thorough price and ingredient comparison. Bounded rationality recognizes that these shortcuts are not inherently irrational—they are adaptive responses to constrained time, attention, and energy.

Bounded rationality puts “satisficing” behavior into overdrive. Satisficing was coined by the same guy who “invented” bounded rationality. Herbert Simon. It is the frame of mind in which we settle for solutions that are “good enough”. For example, when job hunting, a candidate might accept the first offer that meets their basic needs rather than exhaustively searching through every opportunity to find the best fit. Satisficing is an efficient strategy when time and information and limited, and the decision is reversible and relatively low-stakes. But it also highlights how human decision-making veers far from strict rationality.

In real-life situations, people rarely have complete or perfect information about all the variables. To illustrate, when deciding to invest in stock, we only access historical performance and analyst predictions. These are, of course, ineffective ways to gauge an uncertain future. Market crashes and financial ebbs and flows cannot be predicted that way. Bounded rationality encompasses this aspect as well: decisions made with incomplete data, resulting on reliance on existing assumptions and estimates based on past trends.

Grasping how bounded rationality functions has significant implications for system, policy, and product design. Simplifying processes like tax filing and healthcare enrollment accommodates people’s natural constraints of cognition and time. Policymakers and designers can utilize insights from bounded rationality to guide people toward better choices without overwhelming them with data. That’s where choice architecture and nudge theory come in.

The bottom line is that people are far from perfectly rational, logic-based decision-makers. Rather, they are influenced by the environment, limitations, preferences, desires, social norms, and biases. By acknowledging our bounded rationality we can make more accurate predictions of our own behavior. We do this by observing ourselves and learning about biases. The goal is that we’re able to navigate our decisions with a sprinkle of deliberation. People are messy. Put the pieces together. If only a little bit.