Tracing the Path from Rationality to Bounded Rationality: The Contributions of Daniel Kahneman and Amos Tversky

Human behavior, particularly the decision-making process in uncertain situations, has been studied through two contrasting approaches in economics. One is the ‘Rationality Approach’, which employs mathematical models based on a set of axioms and seeks to provide an analytical solution, similar to the economic models of efficiency and equilibrium. The second and relatively new approach is the ‘Behavioral Approach,’ i.e., the study of human behavior in actual circumstances, with an emphasis on the importance of psychological factors influencing it. The perfect rational‘homo œconomicus,’ who possesses complete information about the choices available and has an analytical mind to foresee the results of choosing among these alternative options, has been at the heart of economic analysis and has passed through a long process of evolution. The concept of rationality continued to dominate economic arguments until Herbert Simon introduced the concept of Bounded Rationality. He argued that decisions can be rational, irrational, or inconsistent due to limited cognitive abilities, incomplete information, time constraints, and uncertainties. Human rationality is limited or ‘bounded’—the ‘Behavioral Economists’ attempt to predict how people make economic decisions using experiments and empirical evidence. The Prospect theory of cognitive psychologists (1979) brought a revolutionary change in the rationality concepts. They used the notion of ‘A map of bounded rationality’ wherein rational choices are ‘bounded’ by people’s biases and beliefs. This research paper provides a brief historical overview of the ‘rational economic behaviour argument’ and then analyses the concept of ‘bounded rationality’. Theories that have taken behavioral economics, psychology, and decision-making to new heights, surpassing the limitations of traditional ‘homo œconomicus’ assumptions, have been analyzed in the paper to understand the significance of the contributions of Daniel Kahneman and the late Amos Tversky.