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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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File URL: http://www.uv.es/erices/RePEc/WP/2011/0111.pdf
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Bibliographic Info

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 Branas-Garz & Penelope Hernandez & Juan A. Sanchis, 2011. "Strategic behavior in Schelling dynamics: A new result and experimental evidence," Working Papers 11-14, Chapman University, Economic Science Institute.
  2. Daniel Kahneman, 2003. "Maps of Bounded Rationality: Psychology for Behavioral Economics," American Economic Review, American Economic Association, vol. 93(5), pages 1449-1475, December.
  3. Ballester, Coralio, 2004. "NP-completeness in hedonic games," Games and Economic Behavior, Elsevier, vol. 49(1), pages 1-30, October.
  4. Neyman, Abraham, 1985. "Bounded complexity justifies cooperation in the finitely repeated prisoners' dilemma," Economics Letters, Elsevier, vol. 19(3), pages 227-229.
  5. Ariel Rubinstein, 1997. "Modeling Bounded Rationality," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262681005.
  6. Schelling, Thomas C, 1969. "Models of Segregation," American Economic Review, American Economic Association, vol. 59(2), pages 488-93, May.
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