Bounded rationality and the prospect theory

Bounded rationality is the idea that we make decisions that are rational but within the limits of the information available to us and our mental capabilities. Economists who think of us as ‘boundedly rational’ don’t see us as an ‘economic superman’, or homo economicus that spends his life optimizing the happiness created by every decision. Instead, they see us as satisficers – as people who choose the option that will satisfy their needs and wants without putting too much effort into making sure they’ve considering every single possibility.

Bounded rationality is part of a wider part of economics that looks at how we decide between different choices (or prospects), called prospect theory. Prospect theorists think we’re loss-averse; we remember losses more than gains and go way out of our way to protect against any loss, even the smallest ones. At the same time, though, we rarely take low probability events seriously. This makes us likely to do some extremely risky things without properly considering the worst-case scenarios.

  • Not buying an insurance policy and saving the cost of premiums.
  • An ill patient beginning an unproven treatment.
  • An entrepreneur entering a venture without market research.
  • Considering UI, not the UX.

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