Assumptions bounded rationality

If human behavior is rational, one would expect actions that maximize long term utility. Since each individual is free to be strategic within constraints, the actions of the individual should reflect an attempt at maximizing long term utility. However, such actions are affected by the individual’s assumptions about the present and the future. This basic set of assumptions is what defines each individual and not the actions taken in accordance with them. It is possible that actions can be predicted if assumptions are known and hence the individual is only differentiated by her assumptions. Assumptions, however, are formed over time – influenced by the environment, friends, culture, religion and the society at large that constantly interact with the individual.

All catalysts for behavioral modifications – through incentives in private markets such as companies and profits in public markets – work on influencing the individual’s actions given generic assumptions. The theories that explain the working of the firm and the markets, implicitly assume that bounded rationality occurs because of limited information. It may not be the lack of information that bounds rationality – perhaps it is the excess of it. Since assumptions are based on information gathered by the individual over time through various actions, the more information is available, the more varied the assumptions are likely to be among individuals. This is because assumptions are the result of the processing of information by the individual, affected by unique environmental characteristics. Hence, we may find rationality is bounded because of variety in assumptions aided by excess information.

Thus, it is possible that rationality cannot be defined in the absence of assumptions. If assumptions are hidden, rationality cannot also be tested. Since assumptions are defined by the individual, they cannot be rejected. It is likely that rationality will be high under two conditions. A complete lack of information may mean generic assumptions and thus an ignorant individual is possibly rational. Similarly, a lack of variety in assumptions – as may happen if human society advances to the next level - may enhance the probability of rationality. So, it is not lack of information that creates bounded rationality; it is the variety in assumptions held by the individuals.