Relation to current developments in formal decision theory

It is interesting and even a bit ironical that at the very time when we have learned to build rather precise and empirically verified theories of rational human decision-making there should be a vigorous renaissance of formal theorizing about economic man. The renaissance can be dated from the remarkable progress in game theory, owing initially to von Neumann and Morgenstem, on the one hand, and, on the other hand, the equally remarkable and closely related progress in statistical decision theory, owing to Neyman and Pearson, to Wald, and to Savage.47

The von Neumann and Morgenstem game theory involves at least five separate and distinct concepts, all of them important.

  1. Representing possible future behavior as a “tree,” with branches radiating from each choice point, so that the individual must select at each such point the appropriate branch to follow.
  2. Taking the minimax (selecting the branch that will give the best result in the face of a competitive opponent) as the definition of rational choice in a competitive situation.
  3. Using a mixed strategy (e.g., bluffing) in a competitive situation to prevent one’s move from being anticipated by the opponent.
  4. Defining rational choice in competitive situations with more than two players in terms of the possibilities of forming coalitions.
  5. Assuming that, in the face of uncertainty, where only the probability distribution of outcomes is known, the decision-maker has a cardinal utility function and is choosing so as to maximize its expected value.

The theory of bounded rationality in Administrative Behavior incorpo- rates item (1) of this list and is compatible with items (3) and (4), but the remaining items characterize economic man rather than the administrator and are not part of the model used here. This vital distinction has sometimes been overlooked by commentators, who have mistakenly supposed that the term “rational” in this book has essentially the same meaning as it has for classical economists, game theorists, and statistical decision theorists.

Closely related to game theory is the hypothesis in modem economics of rational expectations. The idea underlying rational expectations is that all decision-makers have accurate knowledge of the true equilibrium level of the economic system, that each decision-maker assumes that all the others have the same knowledge and beliefs based on it, and that all actors form expectations about the future and make decisions on the basis of this knowledge and these beliefs.

Neither game theory nor rational expectations take into account the severe limits of  the decision-maker’s actual knowledge and computational powers in the face of the real world. They   lead   in   almost   a   diametrically   opposite direction to that followed by a theory of bounded rationality.

Source: Simon Herbert A. (1997), Administrative Behavior, Free Press; Subsequent edition.

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