The Concept of Bounded Rationality - Essay Example

Simon and Bounded Rationality and Section Simon and Bounded Rationality Herbert Simon studied and wrote about problem solving and the decision making process across academic fields. In his lifetime, June 15, 1916 to February 9, 2001, he considered those two topics within the multi-disciplinary approach: sociology, psychology, management science, economics, political science and philosophy. Simon observed that the public sector role was increasing, adding complexity to social problem solving and decision making. Other concerns, such as the ethic of environmentalism or “improved life style”, were unquantifiable, un-measurable and thereby filled with uncertainty. These observations lead to Simon’s rejection of the classical economic assumption of prefect-knowledge and to derive “bounded rationality” in decision making (Simon, etal, 1987). “In (‘On how to decide what to do’) (Simon) claims, rightly, that traditional economics has too often been concerned with what decisions are made rather than how they are made.” (Hunt 1) How decisions are made is a better real world indicator of how resources are allocated, which is the study of economics. (Hunt 2) Simon’s interest was in how man processes the limited available information and with imperfect logic. Bounded rationality “refers to peoples limited ability to make comparisons, to see into the future, and, more generally, to process information”. (Cyret 63) Simon created the term “satisficing”, presumably a hybrid term mixing satisfying and sufficing, to indicate achieving the perceived best position with imperfect information. Preferring a blend of thinking, laboratory work and empirical observations of thinking and decision making, Simon wanted economists to get out of the think tanks and go observe business people making decisions. (Cyret) Simon started with the conviction that human rationality was bounded externally by social constraints and internally by cognitive restraints (Sent 227). People were not truly free to make decisions since conformity and possibility were unquantifiable constraints in the process. Bounded rationality was not concerned with symmetry or macroeconomic functions at all. It is a decision making and problem solving theory not meant to strengthen neoclassical economic thought like Nash’s game theory which Simon considered crude and incomplete. In Simon’s theory, quantification is used to enhance rationality, not create it. The management situation sets the conditions for rational thought; therefore some actions are predisposed to be viewed as nonworking solutions (Mankelwicz 60). Common sense, or heuristics, actually applies available metrics as a screening tool. “Human perception may be as bounded in scope as our rationality”. (Mankelwicz 63). Quantitative results may be viewed as symbols, talisman. Managers may experience numbers as moral symbols, guideposts (Mankelwicz 64) Technical rationality, degree of quantification, economic, social, legal politics and political stakeholders, although largely invisible, impact the final decision, certainly the reasonable solution possibilities (Mankelwicz 65). Simon studied bounded rationality, the decision making process, under several disciplines allowing him to consider “decomposability”, the breakdown of problems into hierarchies, the systems of considering means and ends to reach a decision (Augier & Frank 584). Applying rationality, people cannot have perfect information. So, the decision making process is like the scientific methods of laboratory testing and field data collection. Neither is the sole path to truth. Neither is the sole source of perfect decisions. (Hunt 2) Managers must reach decisions through satisficing, that is being at least as optimal as the competition. It is possible the cost of optimization is greater than the reward. (Hunt 2) As early as the 1960’s, theories of systems were forming. “A system may be defined as an orderly grouping of separate but interdependent components for the purpose of attaining some predetermined objective”. (Mockler 53) Systems theory attempts to create a unifying theory of explanation of differing expertise. Hierarchy, orderly arrangement of components, must be in place no matter how complex. Interdependence means communication. Interaction within the system must be goal oriented. The system is the decision making environment. (Mockler 54) Bounded rationality as a foundation stone to behavioral economics rejects the long-established maximization theory. (Hatchuel 260) Simon’s next step was formulating design theory, where creative thinking formulates the problem first. Problems are unfamiliar and poorly defined situations. His model used to explain this theory involved two different decisions: one pick from a list of goods that already exists; the other is to create something unique. In either case, success is not completely in the hands of the problem solver/decision maker. Choosing among the existing is choosing among other conventions, thoughts and mores. Successfully creating something unique depends on the reaction of the intended audience. The irony is that problem solving and decision making are skills, and skills require practice, not problem solving or decision making. (Hatchuel 269) Subjective Expected Utility (SEU), the traditional unit of measurement for the soundness of decisions, is a quantitative look, not at statistical driven decisions, but perfect-knowledge decisions. The SEU theory translates poorly in literal applications, such as the prisoners’ dilemma. (Simon etal. 12) In actual laboratory testing in game theories, people satisfice, then react tit for tat against those who cross them or help them. (Simon etal. 19) Another weakness in SEU theory was problem framing. The way a problem is presented affects the decision making process. One example was the credit card industry arguing over whether price differences should be called cash discounts or credit surcharges. The statements have equivalent real effects; however, the psychology concerns legitimacy. Are purchases based on the use of credit cards the normal condition or is paying cash the normal condition? People want to conform. (Simon etal. 22) SEU results skew as wealth and status change. Wealthy people become more averse to risk. (Baskharan 233) The SEU advocates suggest that repetitive statistical bias in lab studies may not be rational as much as a shortcut, heuristics, lazy thinking as part of maximization. (Baskharan 233) Another trend is the way experts distill facts to recognizable bites, then use intuition and judgment to determine a course of action, the heuristics-rules of thumb method. Certainly, this method is not based on perfect information. (Simon etal. 24) The public sector’s imposition in decision making relies on agenda setting and stating problems so the solution is apparent. One tool in the near future is artificial intelligence (AI) to be used as an aid in pattern recognition. Since computers can run innumerable scenarios based on mathematical models in very short time, AI may soon be used to present the probabilities of outcomes for each variable and decision. (Simon etal. 26) Mankelwicz, etal. build on Simon’s work today: “Our main hypothesis is that human agents are limited decision makers but ‘good’ natural designers (including social interaction as a design factor)”. (Mankelwicz etal. 270) This policy criticizes perfect choice theory, since human agents are considered poor choosers. (Mankelwicz 271) Simon began his career at a local government. the decisions making of his department intrigued him. He studied the decision-making process, how inputs were determined and then studied management reaction. He viewed this process as a manifestation of human behavior in management. In his analysis, Simon finds the administrative decision degrades to two major components: 1. Cost Element: Required for decision-making, implementation of money, time and effort during the preparation phase and the compilation of data and information, classification, propose alternatives and evaluation. 2. Results of Resolution: This element is complex as it relates to the goals envisaged by the decision maker, and how the problem is framed. Whether these goals conflict with personal goals, public service or for-profit public service. Is the resolution in harmony with the policy and the outline of the organization? Simon explains that the administrative decision cannot be rational 100% since it is not possible for all the elements of consent, like the availability of knowledge of all possible solutions and the results of each solution; so the public policy administrator must choose among available alternatives and solutions. Simon’s thesis is that the Director must be satisfied with solutions acceptable rather than optimal solutions. “A frequent practice in the social sciences is to bemoan our present ignorance while making optimistic predictions about future knowledge.” (Simon 2001) Just before his death, Simon wrote a summary article concerning the state-of-the-art decision making field of study. In that article (Simon 2001) Simon discusses the following: 1. Operational Research and Management Science (31-2). New mathematical tools are available to managers and are being applied to decide good and best decisions. Simon notes that for profit companies are utilizing these tolls more so than the public sector. Although these tools have their genesis in World War II as operational analysis, the government has clung to the traditional economic models in their decision matrix. 2. Optimality (32-3): Scheduling procedures such as Gantt Charts or Program Analysis and Review Technique (NetMBA 2011) (PERT) which combine common sense inputs and mathematical logic. Gaming scenarios and rigorous axiomatic systems have advanced management preparedness to make decisions, or even define problems. 3. Experiments on Decision Making (33-4): This area blossomed over the last few years of Simon’s life. Organizational behavior and institutional “think” are assessed as like entities because real scenarios are hard to duplicate in the lab. 4. Persuasion and Evocation (34-5): The process is inputs of premises, outputs of conclusions. But outputting conclusions serves as the next input. So, persuasion begins with selective inputs of premises. Conflicting inputs are not rare. The question in this research is the motivation to participate in inputs. Are the inputs to steer a decision toward a personal goal? A corporate goal? In the best interest of? Even in foreign trade, ideology and self-interest are secondary hurdles compared to institutional structures that block communications. 5. The Structure of Decisions (35-7): Systemized common sense refers to behavior and choice within an organization. Again, conformity is an input. Studies of this type look at computerization as a tool of this conformity. Several studies have continued since Simon’s death: Quality in Innovation (Gidel etal) 1. Each innovation necessarily creates a new process by which to develop and implement the innovation (1). This means that before a product can be designed, a project must be designed (2). 2. The risk management approach is recently traditional in that the steps closely match those of innovation with two exceptions (2) Premature project design as a format can decrease innovation itself. Operational risk identification may damper innovation since the risks are either difficult to identify or impossible to estimate. 3. The circumstances described cause a shift from performance management to value management, allowing local custom to have inputs (3) This leads to managing decisions for effectiveness rather than control of performance. 4. Once a project is okayed by upper management, the project manager chooses a definition of success and models goals accordingly. Then the construction of the method begins. 5. Five approaches to project construction are (5-6): Philosophical Approach Theoretical contributions and the quality principle Systemic modeling of the design process Experimentation Study and Comparison with other models 6. The Philosophical approach is flexible to adapt to situations encountered, but not anticipated. It is a more iterative approach to risk management and project management where new knowledge is reconsidered in the overall meaning of project goals. 7. Theoretical approach is a more traditional optimization approach whereby all stakeholders are perfectly in tune with project goals. 8. Systematic modeling helps in small bites of projects. It helps communications within a phase of a project but tends to become unclear in the big picture. Operationally, it helps facilitate design processes and redesign processes. But the two phases must be separated for efficiency. 9. Benchmarking the project to control completion and scheduling is wise. Project control keeps the stakeholders on the optimum path to completion. 10. The decision making framework involves five principles (10-13): Objectification is the process of building a shared language and therefore purpose of project goals. Construction of Finalities relates to value management. The final goal is project completion to achieve a value, not a specific end. Confrontation is management of differing points of view. The feedback in projects can cause differences of opinion. The ultimate goal, though, must remain intact. Confrontation manages these differences and keeps the team participating fully. Association of finality relates to everyone understanding how their task fits the big goals of the project. The interdependencies of the tasks. Anticipation refers to the need to understand that intermediate goals can change with new information. Not only can they, but they will. Anticipating these changes and embracing them as an acknowledgement that the objective has not changed but the route to achieve it has is important to all stakeholders. 11. The outlined method requires the proper company ethic of collaboration and understanding projects continue under uncertain conditions, changing conditions. This methodology builds on Simon’s bounded rationality theory. However, others disagree and consider Simon to ignore context of decisions. (Mousavi and Garrison 2003) The basis for the disagreement is whether or not deliberation, part of the decision process, is end goal oriented or option gathering oriented. The context might be self concern for keeping a job or being part of a group rather than an optimizing company decision (150). In conclusion, Simon was a very influential thinker for most of the 21rst century. His contributions in bringing many disciplines to the table to discuss human behavior as it relates to problem solving and decision making is as important as his contributions to the controversy of bounded rationality versus SEU. Many disciplines use his theories to manage and lead their organizations, and as importantly, build uncertainty into different project managements and business decisions. Simon encouraged economists to get out of the think tank and gather empirical data. Watch how people allocate not what they do. Because other outside factors and players affect the success of decisions, Simon coined the term satisficing to mean the best choices under the conditions the choice was made. This created something of a paradox and illusion of choice. Choices might be made for outside reasons. Lyon and Simon wrote of the elasticity of cigarette smoking as a purely economic decision. (2001) The decision to smoke or not to smoke is actually defined environmentally, socially and habitually. Simon would suggest the price inelasticity has little to do with changing this behavior. Smoking won’t change, but how they smoke would. References Augier, Mie and Frank, Katherine Simon. (2002) “Introduction: Herbert A. Simon (1916-2001)”. Industrial and Corporate Change, 11:3. (583-86) Bhaskaran, Anand; Parihar, Rahul & Prakhya, Srinivas. (2008) “Approaches to Decision Making Under Uncertainty”. IIMB Management Review. June, 2008. (228-239) Cyert, Richard M. (1979) “Portrait: Herbert Simon”. Challenge. (Sep-Oct) (62-4) Gidel, T., Gautier, R. & DuChamp, R. (2005) “Decision-making framework methodology: an original approach to project risk management in new product design”. Journal of Engineering Design. 16:1 (1-23) Hunt, Norman C. (1980) “Herbert Simon: appreciation and aspiration”. Managerial and Decision Economics, 1:1. (1-3) Hutchuel, Armand. (2001) “Towards Design Theory and Expandable Rationality: the unfinished program of Herbert Simon”. Roundtable: Cognition, Rationality and Governance. (260-273) Lyon, Herbert L. and Simon, Julian L. (2001) “Price elasticity of the Demand for Cigarettes in the United States”. American Journal of Agricultural Economics (888-895) Mankelwicz, John and Kitahara, Robert. (2010) “Quantification, Rationality, and Management Decisions”. Journal of Business & Economics Research, 8:5 (59-70) Mockler, Robert J. (1968) “The Systems Approach to Business Organization and Decision Making”. California Management Review. 11:2 (53-58) Mousavi, Shabnam and Garrison, Jim. (2003) “Toward a transactional theory of decision making: creative rationality as functional coordination in context.” Journal of Economic Methodology. 10:2 (131-156) NetMBA. (2011) “PERT”. NetMBA: Business Knowledge Center. http://netmba.com/operations/project/pert/. Web. Accessed 19 March 2011. Sent, Esther-Mirjam. (2005) “Simplifying Herbert Simon”. History of Political Economy 37:2. (227-232) Simon, Herbert A. etal. (1987) “Decision Making and Problem Solving”. Interfaces, 17:5. (11-31) Simon, Herbert A. (2001) “Administrative Decision Making”. Public Administration Review. (31-7) Read More