Bounded Rationality: Everything You Need to Know!

What is Bounded Rationality?

Bounded rationality explains why humans often make decisions that are “good enough” rather than optimal. We are “bounded” in our ability to be perfectly rational due to cognitive limitations, time constraints, and incomplete information.

Traditional economic theory assumes that individuals are rational agents who maximise utility. However, Herbert Simon, a pioneer of behavioural economics, challenged this view. He introduced the concept of bounded rationality and famously used the scissors metaphor: just like scissors need two blades to function, understanding decision-making requires considering both personal factors (like cognitive ability) and environmental factors (like available information and time).

“Perfect is the enemy of good.” -Voltaire

Why Can’t Humans Be Perfectly Rational Agents?

Cognitive Constraints

Human cognition is powerful but limited. Classical economics assumes we can process all options logically and exhaustively, but in reality, we use heuristics: mental shortcuts, to simplify decisions. These shortcuts, while helpful, often lead to systematic biases.

For example, anchoring bias causes people to rely too heavily on the first piece of information they receive, even if it’s irrelevant. This deviates sharply from the idea of perfect rationality.

Information Overload and Selective Processing

In today’s data-saturated world, people are bombarded with more information than they can reasonably process. This leads to selective attention and memory bias.

Simon coined the term satisficing, a blend of “satisfy” and “suffice", to describe how people settle for an option that’s “good enough,” rather than perfect. Unlike the classical model, which expects exhaustive evaluation, bounded rationality accounts for our tendency to make simplified decisions based on limited or biased data.

“Our knowledge of the world is fundamentally incomplete… even if it were complete, it would still be computationally near-impossible to produce a precise, unbiased understanding of reality.” - Nassim Nicholas Taleb, Skin in the Game

Time Constraints and Satisficing

Classical models assume unlimited time for decision-making. But in reality, we often face urgent decisions with limited time, pushing us to satisficing strategies.

Why Is This Important?

1. Marketing Labels and Decision Shortcuts

Marketers often exploit bounded rationality by using feel-good labels like “organic,” “sugar-free,” or “whole wheat.” These terms sound healthy, but they’re often vague and misleading. We rarely stop to investigate because the labels satisfy our need to make a quick, “good enough” decision.

2. Policy Design and Public Nudges

Governments and organisations use our bounded rationality to design better interventions. Nudges like defaulting people into pension plans or displaying calorie counts help us make healthier or smarter choices without forcing them. Understanding bounded rationality allows policy-makers to work with human limitations, not against them.

3. Everyday Overwhelm and Burnout

In daily life, decision fatigue is real. From choosing what to eat to managing tasks, our brains are constantly simplifying choices to cope. Recognising bounded rationality helps us be kinder to ourselves; we’re not lazy or careless; we’re just trying to manage cognitive overload.

Implications for Economic Models and Policies

Bounded rationality has major implications for how we build economic models and design public policy. Behavioural economics calls for more realistic models that incorporate cognitive biases and human limitations.

In policy, understanding how people actually behave leads to better interventions. For example, nudges: subtle changes in how choices are presented, can guide individuals toward decisions that improve their well-being without restricting freedom of choice.

Conclusion

Bounded rationality offers a powerful critique of the unrealistic expectations of classical economic theory. Acknowledging our cognitive limits, our vulnerability to information overload, and our lack of time, it presents a more realistic, human view of decision-making.

Behavioural economics doesn’t just bridge the gap between theory and reality—it enriches our understanding of how people actually think, choose, and behave in complex environments.