MODELING BOUNDED RATIONALITY IN ECONOMIC THEORY: Four examples

The paper provides an introduction to the growing literature in Economics on models of Bounded Rationality, in which reasoning procedures are the cornerstones of the model. Four models are presented, each of which demonstrates a different type of Bounded Rationality: (i) Limited ability to solve a set of propositions: A mechanism design problem is investigated in an environment where agents try to cheat effectively using a procedure which is anchored in the truth. (ii) Reducing the complexity of strategies: Each player in a Repeated Prisoner’s Dilemma desires not only to increase his payoff but also to reduce the complexity of his strategy. (iii) Belief formation on the basis of a small sample: A model of manipulative voting is presented in which a voter forms beliefs about his vote being pivotal based on a small sample of observations of other voters’ intentions. (iv) Diversified views of the world: A seller exploits differences in buyers’ abilities to recognize time series patterns in order to increase his profits beyond what they would be with a fixed price.