Bounded Rationality:
The Two Cultures
Konstantinos Katsikopoulos
Max Planck Institute for Human Development
Center for Adaptive Behavior and Cognition (Deputy Director)
October 30, 2014
Masters Course on Pluralism in Economics, University of Hamburg
Don’t worry if you are not sure what
bounded rationality is. My point today is
exactly that there are different versions of it.
Herbert Simon
C. P. Snow
Culture here means an approach to research on
bounded rationality that has technical aspects
(data, models) as well as story telling aspects.
I will argue for the following:
There exist two distinct cultures of research on
bounded rationality and they lead to two different
approaches to theory, practice and policy.
The two cultures of bounded rationality:
Idealistic: pursues a minimal departure from
neoclassical economics ideals of omniscience and
optimization of a utility function
(by adding factors such as probability weighting or
inequity aversion to the utility function).
Pragmatic: accepts that people sometimes ignore
information and use simple rules of thumb in order
to achieve satisfactory outcomes.
Katsikopoulos (2014), Journal of Economic Methodology
Technical aspects of
bounded rationality
(10, ½ ; 0, ½)
or
(4, 1)?
The unbounded rationality solution:
Decide for (10, ½; 0, ½) over (4, 1) if
v(10) × ½ + v(0) × ½ > v(4).
Kahneman and Tversky (1979),
Econometrica
Brandstätter, Gigerenzer and
Hertwig (2006), Psychological Review
Brandstätter et al (2008), Psychological Review
Katsikopoulos and Gigerenzer (2008), Journal of Risk and Uncertainty
Katsikopoulos (2014), Journal of Economic Methodology
(1), (2) and (3):
Optimization and satisficing
(4), (5) and (6):
Testing the models
Ken Binmore
Utility function of responder: x – [(1 – x) – x]
where  > 0 measures the responder’s envy due
to earning less than the proposer;
Utility function of proposer: (1 – x) – [(1 – x) – x]
where  > 0 measures the proposer’s discomfort
due to earning more than the responder.
Fehr and Schmidt (1999), Quarterly Journal of Economics
Possible rules of proposer: offer x = ½ or the
largest possible x which is smaller than ½;
Possible rules of responder: accept all x > 0 or only
those x > x* where x* is what she offers.
Hariskos et al (2014), Working Paper
Story telling aspects of
bounded rationality
The two stories:
Idealistic: People systematically behave irrationally,
but because they are in principle able to figure
out how to behave rationally, they should keep
trying to do so (frustrating).
Pragmatic: If people are educated to use the right
tool in the right situation, they do well
(empowering).
Bond (2009), Nature; Katsikopoulos (2014), Journal of Economic Methodology
Katsikopoulos (2014), Journal of Economic Methodology
There exist two distinct cultures of research on
bounded rationality and they lead to two very
different approaches to theory, practice and
policy.
Time will tell what will come out of this tension.
But if we are not aware that it exists or do not
analyze it, we cannot hope to make something
good out of it.