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Incorporating Limited Rationality into Economics

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  • Matthew Rabin
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    Abstract

    Harstad and Selten (this forum) raise interesting questions about the relative promise of optimization models and bounded-rationality models in making progress in economics. This article builds from their analysis by indicating the potential for using neoclassical (broadly defined) optimization models to integrate insights from psychology on the limits to rationality into economics. I lay out an approach to making (imperfect and incremental) improvements over previous economic theory by incorporating greater realism while attempting to maintain the breadth of application, the precision of predictions, and the insights of neoclassical theory. I then discuss how many human limits to full rationality are, in fact, well understood in terms of optimization.

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    File URL: http://www.aeaweb.org/articles.php?doi=10.1257/jel.51.2.528
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    Bibliographic Info

    Article provided by American Economic Association in its journal Journal of Economic Literature.

    Volume (Year): 51 (2013)
    Issue (Month): 2 (June)
    Pages: 528-43

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    Handle: RePEc:aea:jeclit:v:51:y:2013:i:2:p:528-43

    Note: DOI: 10.1257/jel.51.2.528
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    References

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    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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    1. Matthew Rabin., 1992. "Incorporating Fairness into Game Theory and Economics," Economics Working Papers 92-199, University of California at Berkeley.
    2. Tversky, Amos & Kahneman, Daniel, 1992. " Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 297-323, October.
    3. Spiegler, Ran, 2011. "Bounded Rationality and Industrial Organization," OUP Catalogue, Oxford University Press, number 9780195398717.
    4. Rabin, Matthew & Vayanos, Dimitri, 2007. "The Gambler's and Hot-Hand Fallacies: Theory and Applications," CEPR Discussion Papers 6081, C.E.P.R. Discussion Papers.
    5. Stahl, Dale II & Wilson, Paul W., 1994. "Experimental evidence on players' models of other players," Journal of Economic Behavior & Organization, Elsevier, vol. 25(3), pages 309-327, December.
    6. Matthew Rabin, 2001. "Inference by Believers in the Law of Small Numbers," Method and Hist of Econ Thought 0012002, EconWPA.
    7. Laibson, David I., 1997. "Golden Eggs and Hyperbolic Discounting," Scholarly Articles 4481499, Harvard University Department of Economics.
    8. Sendhil Mullainathan, 2002. "A Memory-Based Model Of Bounded Rationality," The Quarterly Journal of Economics, MIT Press, vol. 117(3), pages 735-774, August.
    9. Matthew Rabin, 2013. "An Approach to Incorporating Psychology into Economics," American Economic Review, American Economic Association, vol. 103(3), pages 617-22, May.
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    Cited by:
    1. R. M. Harstad & R. Selten., 2014. "Bounded-Rationality Models: Tasks to Become Intellectually Competitive," VOPROSY ECONOMIKI, N.P. Redaktsiya zhurnala "Voprosy Economiki", vol. 5.
    2. Guido Baldi, 2014. "Endogenous preference formation on macroeconomic issues: the role of individuality and social conformity," Mind and Society: Cognitive Studies in Economics and Social Sciences, Fondazione Rosselli, vol. 13(1), pages 49-58, June.

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