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Chapter 14: Bounded Rationality and Organizational Economics
14 Bounded rationality and organizational economics Nicolai J. Foss In very overall terms the existing research efforts on bounded rationality may be understood as a very diverse set of attempts to elaborate and examine the insights that: (1) the human capacity to process information is limited (Simon, 1955); (2) humans try to economize on cognitive effort by relying on short-cuts (‘heuristics’; Simon and Newell, 1972); and (3) because of (1) and (2), as well as other factors, such as the influence of emotions on cognition, human cognition and judgment is subject to a wide range of biases and errors (Tversky and Kahneman, 1986; Rabin, 1998). Economists’ thinking about the role of rationality (bounded as well as full) has surprisingly often been done with reference to the business firm. Thus, the issue has been highlighted in debates ranging from the descriptive validity of profit maximization in the 1940s over Herbert Simon’s criticism of oligopoly theory (Simon, 1979) to modern debates on incomplete contracting and therefore issues that are central to new institutional economics, such as efficient firm boundaries (for example, Williamson, 1985; Hart, 1990; Tirole, 1999). The reason why economists have associated firm organization and bounded rationality (BR) arguably lies in the inherent complexity and uncertainty of decisions relating to competitive strategy, investment decisions, the design of human resource management systems, and so on. By comparison most consumption choices seem relatively simple and more given to a treatment in terms of the standard maximizing model. Recently, BR has, under the banner...
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