Compare and contrast Prospect Theory and Bounded Rationality. In your journal, discuss which theory you believe to be more valid and why.
Critics of the rational model argue that it makes unrealistic assumptions in order to simplify possible choices and predictions.
Summarize the inherent flaws and arguments against the rational model of decision-making within a business context
A framework for understanding and often formally modeling social and economic behavior.
The idea that decision-making is limited by the information available, the decision-maker's cognitive limitations, and the finite amount of time available to make a decision.
One who seeks a satisfactory solution rather than an optimal one.
Critics of rational choice theory – or the rational model of decision-making – claim that this model makes unrealistic and oversimplified assumptions. Their objections to the rational model include:
Alternative theories of how people make decisions include Amos Tversky's and Daniel Kahneman's prospect theory. Prospect theory reflects the empirical finding that, contrary to rational choice theory, people fear losses more than they value gains, so they weigh the probabilities of negative outcomes more heavily than their actual potential cost. For instance, Tversky's and Kahneman's studies suggest that people would rather accept a deal that offers a 50% probability of gaining $2 over one that has a 50% probability of losing $1.
Other researchers in the field of behavioral economics have also tried to explain why human behavior often goes against pure economic rationality. The theory of bounded rationality holds that an individual's rationality is limited by the information they have, the cognitive limitations of their minds, and the finite amount of time they have to make a decision. This theory was proposed by Herbert A. Simon as a more holistic way of understanding decision-making. Bounded rationality shares the view that decision-making is a fully rational process; however, it adds the condition that people act on the basis of limited information. Because decision-makers lack the ability and resources to arrive at the optimal solution, they instead apply their rationality to a set of choices that have already been narrowed down by the absence of complete information and resources.
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