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Incorporating Limited Rationality into Economics

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  • Matthew Rabin

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.

Suggested Citation

  • Matthew Rabin, 2013. "Incorporating Limited Rationality into Economics," Journal of Economic Literature, American Economic Association, vol. 51(2), pages 528-543, June.
  • 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 listed on IDEAS

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    1. 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.
    2. Matthew Rabin & Dimitri Vayanos, 2010. "The Gambler's and Hot-Hand Fallacies: Theory and Applications," Review of Economic Studies, Oxford University Press, vol. 77(2), pages 730-778.
    3. Spiegler, Ran, 2014. "Bounded Rationality and Industrial Organization," OUP Catalogue, Oxford University Press, number 9780199334261.
    4. 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.
    5. Matthew Rabin, 2013. "An Approach to Incorporating Psychology into Economics," American Economic Review, American Economic Association, vol. 103(3), pages 617-622, May.
    6. Rabin, Matthew, 1993. "Incorporating Fairness into Game Theory and Economics," American Economic Review, American Economic Association, pages 1281-1302.
    7. David Laibson, 1997. "Golden Eggs and Hyperbolic Discounting," The Quarterly Journal of Economics, Oxford University Press, vol. 112(2), pages 443-478.
    8. Matthew Rabin, 2002. "Inference by Believers in the Law of Small Numbers," The Quarterly Journal of Economics, Oxford University Press, vol. 117(3), pages 775-816.
    9. Sendhil Mullainathan, 2002. "A Memory-Based Model of Bounded Rationality," The Quarterly Journal of Economics, Oxford University Press, vol. 117(3), pages 735-774.
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    Citations

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    Cited by:

    1. Gerardo Infante & Guilhem Lecouteux & Robert Sugden, 2016. "Preference purification and the inner rational agent: a critique of the conventional wisdom of behavioural welfare economics," Journal of Economic Methodology, Taylor & Francis Journals, pages 1-25.
    2. Carolina Laureti & Ariane Szafarz, 2017. "Behavioral Banking: A Theory of the Banking Firm with Time-Inconsistent Depositors," Working Papers CEB 17-028, ULB -- Universite Libre de Bruxelles.
    3. Robert Sugden, 2014. "Characterising competitive equilibrium in terms of opportunity," Working Papers 14-02, Chapman University, Economic Science Institute.
    4. R. M. Harstad & R. Selten., 2014. "Bounded-Rationality Models: Tasks to Become Intellectually Competitive," VOPROSY ECONOMIKI, N.P. Redaktsiya zhurnala "Voprosy Economiki", vol. 5.
    5. Lunn, Pete & Somerville, Jason J., 2015. "Surplus Identification with Non-Linear Returns," Papers WP522, Economic and Social Research Institute (ESRI).
    6. Pedro Bordalo & Nicola Gennaioli & Andrei Shleifer, "undated". "Diagnostic Expectations and Credit Cycles," Working Paper 350646, Harvard University OpenScholar.
    7. Pedro Bordalo & Nicola Gennaioli & Andrei Shleifer, "undated". "Diagnostic Expectations and Credit Cycles," Working Paper 350646, Harvard University OpenScholar.
    8. Guido Baldi, 2014. "Endogenous preference formation on macroeconomic issues: the role of individuality and social conformity," Mind & Society: Cognitive Studies in Economics and Social Sciences, Springer;Fondazione Rosselli, vol. 13(1), pages 49-58, June.
    9. Xavier Gabaix, 2017. "Behavioral Inattention," NBER Working Papers 24096, National Bureau of Economic Research, Inc.
    10. Timo Henckel & Gordon Menzies & Peter Moffat & Daniel J. Zizzo, 2017. "Sticky Belief Adjustment: A Double Hurdle Model and Experimental Evidence," Working Paper Series 40, Economics Discipline Group, UTS Business School, University of Technology, Sydney.

    More about this item

    JEL classification:

    • B49 - Schools of Economic Thought and Methodology - - Economic Methodology - - - Other
    • D01 - Microeconomics - - General - - - Microeconomic Behavior: Underlying Principles
    • D03 - Microeconomics - - General - - - Behavioral Microeconomics: Underlying Principles
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations

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