BOUNDED RATIONALITY AND CONTEXT INFLUENCE IN DECISION MAKING

Bounded Rationality is an idea that humans are somewhat rational with several important limitations. This is a challenge to a framework known as the rational choice theory that assumes that people are generally rational. Rational choice theory is widely used in social sciences and underpins a large number of theories in economics. To have a better understanding of bounded rationality, imagine that you are an investor who invests in stock market. You may only have a few minutes to consider a stock trade. Here faced a time constraint. Now, a stock trade may involve hundreds of variables and a high level of uncertainty such that it is not possible for an individual to make an optimal decision in a few minutes.

Often, the context and the framing of the information influence an individual’s judgement and decision making. This phenomenon is called Cognitive bias.

People usually tend to over rely on the first piece of information they receive and then use it as a baseline for comparison. This is called Anchoring bias. For example, if the first applicant in a competitive examination has an unusually high-test score, it might set the bar so high that other applicants with more normal scores seem less qualified than they otherwise would.

Sometimes, people assume that because someone is good or bad at one thing, they will be equally good or bad at other things. This is called the Halo Effect.  For example, if a candidate has an exemplary test score, the employer may come to a conclusion that he is also a good leader.

Paying more attention to information that reinforces previously held beliefs and ignoring evidence to the contrary are also a cause of poor judgement. A recruiter who believes that men are more intelligent than women might pay more focus on the aspects of resumes that highlight the intelligence of male applicants.

A person is more likely to go along with a belief if there are many others who hold that belief. This is known as the Bandwagon Effect or “the herd mentality”. People are more likely to vote for a candidate they think is winning.  

Researched have shown that there exists an academic tendency to over-value an individual who displays “brilliant but cruel” behaviour and to attribute less intelligence to people with “nice” behaviour. This Phenomenon is often called The “Jerk” Factor. A recruiting committee can be unduly impressed by an academic star that builds himself up at the cost of behaving disrespectfully toward others.

It is a general human tendency to avoid “bad news” about a decision by ignoring data that might be undesirable. This is known as the Ostrich Effect. Imagine you spends too much money on parking and maybe buying the entire bar a round of drinks well past closing time. Knowing that you have greatly eclipsed your credit card balance, you simply wait for their bill to come instead of investigating the extent of the financial havoc you’ve wreaked upon yourself.

If people were entirely rational, they would consistently make the same decision over and over again when given with identical options, but sometimes people's preferences are dependent on how the options are presented. Psychologists call this type of cognitive bias as the Framing Effect.

Hence, we can say that consumers are not always completely rational in their decisions as prescribed by the traditional economic models. This makes the study of Behavioural Economics necessary as it is a branch of economic research that adds elements of psychology to traditional models in an attempt to better understand decision-making by investors, consumers and other economic participants.