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Individuals are irrational decision makers

Chapter 3 Individuals are prone to errors in judgment


Neoclassical economists of the 19th and early 20th centuries imagined perfectly rational individuals that made decisions to their advantage, or — as economists prefer to say — maximizing their utility . They used the term economic man or homo economicus to describe a rational actor who had complete information about the situation and available options.

Herbert Simon Share this expert HS Herbert Simon recognized that the individuals do not have complete information and even if they did they would not have the mental capacity to process all of the available data. He introduced the term bounded rationality to describe this limitation on the ability of individuals to make entirely rational decisions. According to Simon, individuals don’t make decisions that maximize utility. They make decisions by choosing options that best satisfy their decision criteria in the given situation. Simon called this behavior satisficing .

The field of behavioral economics emerged applies psychology to economics. Amos Tversky Share this expert AT Amos Tversky and Daniel Kahneman Share this expert DK Daniel Kahneman showed with their research that humans do not always make optimal decisions. Many mental shortcuts and biases can lead to people making irrational decisions.

… we are not only irrational, but predictably irrational— … our irrationality happens the same way again and again.
Dan Ariely Share this expert DA Dan Ariely , Predictably Irrational

Humans are not purely rational creatures as imagined by economists. They can be misled into making decisions that are bad for them. So it makes sense to design systems that nudge them in the right direction so that they can make better decisions. To make better decisions, we must understand the limitations and quirks of our minds and design decision-making principles and systems that help us to overcome them.

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