Topic 5 - economics and bounded rationality

Question 1

Assumptions in economics

Answer 1

• Access to all information
• Ability to process all information
• Draw correct conclusions on all information

Question 2

Herbert Simon; problem with economic theory

Answer 2

information is not available to all, information is not free to obtain, information is not free to process. How long are we going to accumulate information?

When the marginal cost of processing the next unit of information is equal to the marginal benefit of doing so, people stop.

We are not looking for the perfect solution, just for the one that satisfies us. “Satisficing” –> looking for information until its “enough”.

Question 3

What is marginal cost?

Answer 3

cost of the next unit. Revenue and the cost, associated with the next one.

Question 4

What is payment?

Answer 4

to give up something for it. Not only money in this sense. Give up for collecting information –> time, mental capacity.

Question 5

Bounded rationality

Answer 5

Suggested by Herbert Simon. When people make decisions, their rationality is limited (bounded). We only seek for information until we are “satisficing” with our decision.

Question 6

Kahneman, Tversky

Answer 6

social psychologists. Series of tests. Prove that people don´t follow a number of “rules” that are rational (and mathematically correct).

Question 7

3 types of errors K&T discovered

Answer 7

Type I: overconfidence
Type II: optimism and wishful thinking; unable to predict correctly when a task will be completed.
Type III: representativeness. Sample size neglect (will jump to conclusions too early, even when there is actually not enough data).
Type IV: belief perseverance (people hang on their established views too long (too much skepticism against established truths)

Question 8

Consequences of K&T findings

Answer 8

• too mange small errors, heuristics to overlook that body of evidence
• utility theory is questioned
• prospect theory is proposed