According to the decision-making process of bounded rationality, we are not inclined to find out all the necessary information that would be required to make a rational decision, because of cognitive and temporal limitations. This causes us to make choices that are satisfactory rather than optimal.

Our choices are still rational, considering the information that is realistically available to us, but may not be rational in lieu of all the possible information and resources. While it is difficult to behave according to perfect economic rationality, which is to maximize benefits while diminishing costs, making decisions based on bounded rationality can cause us to be inconsistent with our objectives.

In any organization or institution, there are complex webs of decision-making.

The decisions that ought to be made by institutions are often with economic principles in mind, but these do not take into account the reality that humans do not function in a perfectly rational way.

While organizations want to make decisions that reflect their economic values and objectives, these decisions are made by individuals. Individuals are influenced by more than mere logic, and sometimes, decision-making individuals in companies have to make quick decisions that will impact the rest of the organization. With constraints like time, the choice that is made may only be satisfactory rather than optimal for the company’s objectives.

Rationality becomes all the more complex in a company where an individual’s optimal choice may not match the optimal choice for the company. Here, the rationality of CEOs and other decision-makers are bound in a different way, by their environment which asks them to put the needs of the company before their own. Bounded rationality is sometimes a necessary imperfection when we understand decision-making as part of a network, rather than theorize rationality based on a ‘perfect’ subject that is not a part of these complexities.

On a daily basis, we have to make hundreds of decisions based on available alternatives. Since we have to make so many decisions in a limited period of time, we are not able to take the time to gather all the information about, or map out the potential effects, of each alternative. Think about how much information would have to be stored in our brains at any given moment for us to be able to make perfectly rational decisions.

Since we are limited by brain capacity (partially due to cognitive biases), time and available information, we have to make decisions using shortcuts. These shortcuts make it easier for us to make decisions, but they challenge our ability to be rational, sometimes leading us to make suboptimal choices.

Bounded rationality causes us to make satisfactory choices, but that does not mean that those choices are optimal. Economists call us “satisficers” instead of “homo economicus”, which means the “perfect rational man/woman”. We make “good enough” decisions instead of the best ones, leading us to choose inconsistently.

We need to be aware of our imperfect decision-making, because businesses will use marketing tactics to try and benefit from it. Often they mark their products with enticing qualifiers and descriptors that have little-to-no meaning, such as the term “cage-free” on a carton of eggs. Other examples include the labels “sugar-free”, “organic” or “whole-wheat”. These qualifiers are vague, and often do not mean what we think they do. We may believe we are buying ethical or healthy options, thereby making a decision that satisfies us, but in reality, we are not achieving the most optimal decision for our ethical or healthy objectives.

Morgan Spurlock, director of Super Size Me 2: Holy Chicken!, explores what the requirements are for restaurants to be allowed to label foods with certain qualifiers. For example, fast-food restaurants are allowed to say that their meat is made from “free-range” chicken if the chickens have the option of going outside for part of the day. That doesn’t actually mean that they go outside. As Sprulock shows in the film, farmers can get away with constructing a fenced space that only extends a few feet outdoors, which they open up for a few minutes each day, and convince consumers that they are being ethical.

If we do not want to be taken advantage of by businesses and marketing, it is important that we maintain an awareness that they are playing into bounded rationality. They know that we don’t have the time to inform ourselves on the fine print of each qualifier or look at the nutritional labels of every product we buy.

Being aware of bounded rationality does not help us to overcome it, because knowing about the limits of our thinking capacity, the information that is available to us, and time, does not make those limitations disappear. It also isn’t effective to try to acquire all knowledge about different alternatives when making a decision; for one, this would take too long, and even if we had access to all the necessary information, we probably wouldn’t be able to process it.

Since, as individuals, we will always be affected by bounded rationality, working in groups or teams can help us overcome some of the limitations of bounded rationality. People come to the table with different brain capacities from their previous knowledge and life-experience. Working on a task together also reduces the amount of time each of us has to spend on it, meaning that we may have more time to do in-depth research about the task at hand, and expand our available information.

Companies and professionals can also use a nudge, a form of choice architecture, which is a thought-out design of environments under which people make decisions. Nudges could help us make optimal rather than satisfactory decisions. For example, the healthiest food options at the grocery store can be placed at eye-level to make us more likely to choose that food.

Economist Herbert A. Simon, Nobel prize winner for his work in behavioral science, first proposed the idea of bounded rationality in 1955 to counter the commonly held belief that being economical was equivalent to being rational. Being rational, under existing economic theories, meant that when an individual was presented with a choice between alternative courses of action, they would be able to make the choice that was optimal. This was called “rationality as optimization”, and Simon’s proposal was very influential in displacing such models.

Simon did not believe existing economic understandings of rationality adequately represented the kind of decisions people made. He proposed bounded rationality to take into account the “access of information, and the computational capacities that are actually possessed by organisms, including man, and the kinds of environments in which such organisms exist.” In other words, he wanted his theory to take into account what information is available to people in making decisions, the limits of humans’ thinking capacity, and the limits of the environment, such as time.

In a subsequent article, Simon famously used a scissor metaphor to describe why traditional economy theory was insufficient for looking at decision-making.⁶ One blade represented human’s brain capacity and the other blade represented the environment under which we make decisions. German psychologist Gerd Gigerenzer, who supported Simon’s model, explained its significance. If we look at either blade of a scissor alone, we cannot understand how it cuts. It is necessary to understand all the different factors that go into decision-making, or, in other words, to look at the factors that cause rationality to be bound.

Decision-making occurs in complex systems in businesses where there are competing influences, and where organizational objectives do not always match individual objectives.

In economic terms, what is rational for a business is what will make them the most money. However, increasingly, consumers are expecting companies to be ethical in their practices, especially when it comes to environmental issues. These pressures lead to conflicting priorities for decision-makers, that both want to maintain their reputation with consumers and prioritize economic gain.

Along with his team, Jens Roehrich, a researcher interested in supply-chain management, examined how 12 companies handled conflicting interests. Roehrich wanted to see how bounded rationality affects companies’ use of sustainable supply chains. The use of sustainable supply chains is environmentally friendly, but often costs more.

The researchers found that a main concern of managers was balancing the trade-off between cost and reputation, as well as what capabilities and resources were available. These trade-offs demonstrate that organizations rarely abide by perfect rationality, and instead, their rationality is bound by different influences and capacities.

Instead of choosing the cheapest supply chain, which would be optimal in economic terms, decision-makers often settled on a compromise between costs and reputation, by choosing a supply chain that was a higher cost but sustainable and ethical. This instance demonstrates that sometimes, bounded rationality is actually more effective than perfect rationality, because we live in a complex world that isn’t black and white when it comes to making decisions.

Perfect economic rationality predicts that we make decisions that will give us the best financial outcome. However, that choice is often not the one we make.

Imagine you won a contest, and you are given two options for your reward. Either you can receive $100 today, or you can wait one month and receive $110. The perfect rational individual would choose to wait one month to receive the larger sum of money, but most people are likely to be satisfied with receiving $100 immediately.

A number of studies have been conducted in these kinds of scenarios. For example, when buying large appliances, customers are more likely to buy models with a low initial price that have high energy rates. These appliances end up costing us more long-term than if we chose models with a higher initial price but lower energy rates. Bounded rationality means that we are limited by our inability to quickly calculate how much electricity will cost over the years, causing us to make a decision that is satisfactory at the time, but not optimal.

In another study, individuals were asked whether they would prefer a free meal at a fancy French restaurant, or a local Greek restaurant.¹⁰ Most chose the French restaurant, but in a subsequent question, when they were asked if they would prefer the French meal in two months or the Greek meal in one month, 57% who had initially chosen French said they’d rather have the Greek meal sooner.

What these studies show is that humans do not act in accordance to perfect economic rationality. Instead, other factors influence our decisions, whether that be convenience, the desire for immediate gratification, limited available information, time, or other cognitive biases.

What it is

Bounded rationality describes the way that humans make decisions that departs from perfect economic rationality, because our rationality is limited by our thinking capacity, the information that is available to us, and time. Instead of making the ‘best’ choices, we often make choices that are satisfactory.

Why it happens

To act according to perfect rationality would require us to not be influenced by any cognitive biases, to be able to access all possible information about potential alternatives, and have enough time to calculate and project the benefits and detriments of each possible choice.

Since it is next to impossible to make decisions that satisfy all those factors we take shortcuts and make decisions that satisfy us, even if they are not the most optimal. Within our temporal and cognitive limitations, we make choices to the best of our understanding and ability, meaning that we are still rational, but not perfectly so.

Example 1 – Supply chain management

According to a model based on perfect economic rationality, company decision-makers would make decisions for their supply-chain that would yield the greatest profit. However, such a model would not take into account other factors like reputation or sustainability. Many companies make decisions for their supply chain where cost is but one of the factors that goes into the decision-making process, leaving room for other influences like sustainability. Bounded rationality takes into account some of the trade-offs that managers have to make that means their decisions do not always fall in line with perfect economic rationality.

 Example 2 – Short-term temptations

Bounded rationality can cause us to make decisions that satisfy us in the short-term, either because we are biased by immediate gratification, or because we do not have the capacity or time to calculate the long-term costs of our decisions. This leads to decisions that are not optimal, such as buying appliances that have a lower initial price but costs us more over time because of energy costs, or to put our preferences to the side to receive a reward sooner.

How to avoid it

It is difficult to avoid bounded rationality, because the limitations that cause us to veer from perfect economic rationality are not ones we are able to change. The effort that would be required to make the best choice is often not worth the difference in benefit gained between a satisfactory and an optimal choice.

However, it can be useful to get multiple opinions on what the best decision is. Working as a team helps us overcome bounded rationality because we lessen limitations; it provides us with multiple perspectives that are not all affected to the same degree by cognitive biases and gives us more time to learn about the possible alternatives in order to arrive at an optimal decision.