Maps of Bounded Rationality

Maps of Bounded Rationality


Daniel Kahneman


Maps of Bounded Rationality

Daniel Kahneman. 2003. (View Paper → )

Herbert A. Simon (1955, 1979) had proposed much earlier that decision makers should be viewed as boundedly rational, and had offered a model in which utility maximization was replaced by satisficing. Our research attempted to obtain a map of bounded rationality, by exploring the systematic biases that separate the beliefs that people have and the choices they make from the optimal beliefs and choices assumed in rational-agent models. The rational-agent model was our starting point and the main source of our null hypotheses, but Tversky and I viewed our research primarily as a contribution to psychology, with a possible contribution to economics as a secondary benefit. We were drawn into the interdisciplinary conversation by economists who hoped that psychology could be a useful source of assumptions for economic theorizing, and indirectly a source of hypotheses for economic research.

Key Points:

Humans have two modes of thinking: "System 1" (fast, automatic, intuitive) and "System 2" (slower, effortful, controlled).

People often make judgments based on System 1, relying on heuristics and biases rather than careful reasoning.

Heuristics like representativeness, availability, and anchoring can lead to predictable errors and biases in judgment.

Framing effects powerfully shape decisions based on how options are presented.

People are loss averse, weighting potential losses more heavily than equivalent gains.

Decisions are reference dependent, evaluated as changes relative to a reference point rather than final states.

People poorly predict their future utility and preferences, exhibiting biases like duration neglect.

Prospect theory better describes actual decision making under risk than expected utility theory.

Economists should incorporate these psychological insights to improve models of behaviour and policy prescriptions.