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Bounded Rationality

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  • Penelope Hernandez

    ()
    (ERI-CES)

  • Coralio Ballester

    ()
    (University Alicante)

Abstract

The observation of the actual behavior by economic decision makers in the lab and in the field justifies that bounded rationality has been a generally accepted assumption in many socio-economic models. The goal of this paper is to illustrate the difficulties involved in providing a correct definition of what a rational (or irrational) agent is. In this paper we describe two frameworks that employ different approaches for analyzing bounded rationality. The first is a spatial segregation set-up that encompasses two optimization methodologies: backward induction and forward induction. The main result is that, even under the same state of knowledge, rational and non-rational agents may match their actions. The second framework elaborates on the relationship between irrationality and informational restrictions. We use the beauty contest (Nagel, 1995) as a device to explain this relationship.

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Paper provided by University of Valencia, ERI-CES in its series Discussion Papers in Economic Behaviour with number 0111.

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Date of creation: Jan 2011
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Handle: RePEc:dbe:wpaper:0111

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Keywords: Behavioral economics; bounded rationality; partial information;

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  1. Juan Miguel Benito & Pablo Brañas-Garza & Penélope Hernández & Juan A. Sanchis, 2012. "Strategic behavior in Schelling dynamics: A new result and experimental evidence," Discussion Papers in Economic Behaviour 0312, University of Valencia, ERI-CES.
  2. Ariel Rubinstein, 2005. "Modeling Bounded Rationality," Levine's Bibliography 784828000000000152, UCLA Department of Economics.
  3. Schelling, Thomas C, 1969. "Models of Segregation," American Economic Review, American Economic Association, vol. 59(2), pages 488-93, May.
  4. Daniel Kahneman, 2003. "Maps of Bounded Rationality: Psychology for Behavioral Economics," American Economic Review, American Economic Association, vol. 93(5), pages 1449-1475, December.
  5. Govindan, Srihari & Robson, Arthur J., 1998. "Forward Induction, Public Randomization, and Admissibility," Journal of Economic Theory, Elsevier, vol. 82(2), pages 451-457, October.
  6. Neyman, Abraham, 1985. "Bounded complexity justifies cooperation in the finitely repeated prisoners' dilemma," Economics Letters, Elsevier, vol. 19(3), pages 227-229.
  7. Ballester, Coralio, 2004. "NP-completeness in hedonic games," Games and Economic Behavior, Elsevier, vol. 49(1), pages 1-30, October.
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