IDEAS home Printed from https://ideas.repec.org/a/sae/miceco/v7y2019i1p7-58.html
   My bibliography  Save this article

Heuristics and Public Policy: Decision-making Under Bounded Rationality

Author

Listed:
  • Sanjit Dhami
  • Ali al-Nowaihi
  • Cass R. Sunstein

Abstract

How do human beings make decisions when, as the evidence indicates, the assumptions of the Bayesian rationality approach in economics do not hold? Do human beings optimize, or can they? Several decades of research have shown that people possess a toolkit of heuristics to make decisions under certainty, risk, subjective uncertainty, and true uncertainty (or Knightian uncertainty). We outline recent advances in knowledge about the use of heuristics and departures from Bayesian rationality, with particular emphasis on growing formalization of those departures, which add necessary precision. We also explore the relationship between bounded rationality and libertarian paternalism, or nudges, and show that some recent objections, founded on psychological work on the usefulness of certain heuristics, are based on serious misunderstandings. JEL classifications: D01, D04, D81, D9

Suggested Citation

  • Sanjit Dhami & Ali al-Nowaihi & Cass R. Sunstein, 2019. "Heuristics and Public Policy: Decision-making Under Bounded Rationality," Studies in Microeconomics, , vol. 7(1), pages 7-58, June.
    • Handle: RePEc:sae:miceco:v:7:y:2019:i:1:p:7-58
    DOI: 10.1177/2321022219832148
    as

    Download full text from publisher

    File URL: https://journals.sagepub.com/doi/10.1177/2321022219832148
    Download Restriction: no
    File URL: https://libkey.io/10.1177/2321022219832148?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    References listed on IDEAS

    as
    1. Sanjit Dhami & Ali al-Nowaihi, 2018. "Rationality in Economics: Theory and Evidence," CESifo Working Paper Series 6872, CESifo.
    2. Roth, Benjamin & Voskort, Andrea, 2014. "Stereotypes and false consensus: How financial professionals predict risk preferences," Journal of Economic Behavior & Organization, Elsevier, vol. 107(PB), pages 553-565.
    3. Hertwig, Ralph, 2017. "When to consider boosting: some rules for policy-makers," Behavioural Public Policy, Cambridge University Press, vol. 1(2), pages 143-161, November.
    4. Victor DeMiguel & Lorenzo Garlappi & Raman Uppal, 2009. "Optimal Versus Naive Diversification: How Inefficient is the 1-N Portfolio Strategy?," The Review of Financial Studies, Society for Financial Studies, vol. 22(5), pages 1915-1953, May.
    5. Caplin, Andrew & Schotter, Andrew, 2008. "The Foundations of Positive and Normative Economics: A Handbook," OUP Catalogue, Oxford University Press, number 9780195328318.
    6. Nicola Lacetera & Devin G. Pope & Justin R. Sydnor, 2012. "Heuristic Thinking and Limited Attention in the Car Market," American Economic Review, American Economic Association, vol. 102(5), pages 2206-2236, August.
    7. Kirchler, Erich & Maciejovsky, Boris, 2002. "Simultaneous Over- and Underconfidence: Evidence from Experimental Asset Markets," Journal of Risk and Uncertainty, Springer, vol. 25(1), pages 65-85, July.
    8. Markus Glaser & Thomas Langer & Martin Weber, 2007. "On the Trend Recognition and Forecasting Ability of Professional Traders," Decision Analysis, INFORMS, vol. 4(4), pages 176-193, December.
    9. Richard H. Thaler & Cass R. Sunstein, 2023. "Libertarian paternalism," Chapters, in: Cass R. Sunstein & Lucia A. Reisch (ed.), Research Handbook on Nudges and Society, chapter 1, pages 10-16, Edward Elgar Publishing.
    10. Ali al-Nowaihi & Sanjit Dhami, 2018. "Foundations for Intertemporal Choice," CESifo Working Paper Series 6913, CESifo.
    11. Bruno Biais & Martin Weber, 2009. "Hindsight Bias, Risk Perception, and Investment Performance," Management Science, INFORMS, vol. 55(6), pages 1018-1029, June.
    12. Chmura, Thorsten & Goerg, Sebastian J. & Selten, Reinhard, 2012. "Learning in experimental 2×2 games," Games and Economic Behavior, Elsevier, vol. 76(1), pages 44-73.
    13. Itzhak Ben-David & John R. Graham, 2013. "Managerial Miscalibration," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 128(4), pages 1547-1584.
    14. Mas-Colell, Andreu & Whinston, Michael D. & Green, Jerry R., 1995. "Microeconomic Theory," OUP Catalogue, Oxford University Press, number 9780195102680.
    15. Ulrike Malmendier & Timothy Taylor, 2015. "On the Verges of Overconfidence," Journal of Economic Perspectives, American Economic Association, vol. 29(4), pages 3-8, Fall.
    16. Robert Sugden, 2008. "Why incoherent preferences do not justify paternalism," Constitutional Political Economy, Springer, vol. 19(3), pages 226-248, September.
    17. Dhami, Sanjit, 2016. "The Foundations of Behavioral Economic Analysis," OUP Catalogue, Oxford University Press, number 9780198715535.
    18. Stephen G. Dimmock & Roy Kouwenberg & Peter P. Wakker, 2016. "Ambiguity Attitudes in a Large Representative Sample," Management Science, INFORMS, vol. 62(5), pages 1363-1380, May.
    19. Matthew Rabin, 2002. "Inference by Believers in the Law of Small Numbers," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 117(3), pages 775-816.
    20. Northcraft, Gregory B. & Neale, Margaret A., 1987. "Experts, amateurs, and real estate: An anchoring-and-adjustment perspective on property pricing decisions," Organizational Behavior and Human Decision Processes, Elsevier, vol. 39(1), pages 84-97, February.
    21. Barberis, Nicholas & Shleifer, Andrei & Vishny, Robert, 1998. "A model of investor sentiment," Journal of Financial Economics, Elsevier, vol. 49(3), pages 307-343, September.
    22. Daniel Kahneman & Amos Tversky, 2013. "Prospect Theory: An Analysis of Decision Under Risk," World Scientific Book Chapters, in: Leonard C MacLean & William T Ziemba (ed.), HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING Part I, chapter 6, pages 99-127, World Scientific Publishing Co. Pte. Ltd..
    23. Herbert A. Simon, 1955. "A Behavioral Model of Rational Choice," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 69(1), pages 99-118.
    24. Dimmock, Stephen G. & Kouwenberg, Roy & Mitchell, Olivia S. & Peijnenburg, Kim, 2016. "Ambiguity aversion and household portfolio choice puzzles: Empirical evidence," Journal of Financial Economics, Elsevier, vol. 119(3), pages 559-577.
    25. Jean-Jacques Laffont & Jean Tirole, 1993. "A Theory of Incentives in Procurement and Regulation," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262121743, December.
    26. Cass R. Sunstein & Richard H. Thaler, 2003. "Libertarian paternalism is not an oxymoron," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, vol. 48(Jun).
    27. Andrew Caplin & Mark Dean & Daniel Martin, 2011. "Search and Satisficing," American Economic Review, American Economic Association, vol. 101(7), pages 2899-2922, December.
    28. B. Douglas Bernheim & Jonathan Skinner & Steven Weinberg, 2001. "What Accounts for the Variation in Retirement Wealth among U.S. Households?," American Economic Review, American Economic Association, vol. 91(4), pages 832-857, September.
    29. George A. Akerlof & Robert J. Shiller, 2015. "Phishing for Phools: The Economics of Manipulation and Deception," Economics Books, Princeton University Press, edition 1, number 10534.
    30. Ulrike Malmendier & Geoffrey Tate, 2015. "Behavioral CEOs: The Role of Managerial Overconfidence," Journal of Economic Perspectives, American Economic Association, vol. 29(4), pages 37-60, Fall.
    31. Simon, Herbert A, 1979. "Rational Decision Making in Business Organizations," American Economic Review, American Economic Association, vol. 69(4), pages 493-513, September.
    32. Heath, Chip & Tversky, Amos, 1991. "Preference and Belief: Ambiguity and Competence in Choice under Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 4(1), pages 5-28, January.
    33. Jonathan Guryan & Melissa S. Kearney, 2008. "Gambling at Lucky Stores: Empirical Evidence from State Lottery Sales," American Economic Review, American Economic Association, vol. 98(1), pages 458-473, March.
    34. Lucas, Robert Jr., 1988. "On the mechanics of economic development," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 3-42, July.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Nahid Unkic & Jasmina Okicic, 2021. "The Relationship between Decision-Making Heuristics and Perceived Quality of Life," Eurasian Journal of Business and Management, Eurasian Publications, vol. 9(2), pages 90-99.
    2. Stuart Shapiro & Debra Borie-Holtz, 2020. "Small business response to regulation: incorporating a behavioral perspective," Palgrave Communications, Palgrave Macmillan, vol. 7(1), pages 1-9, December.
    3. Lijun Liang & Tongxin Dai & Mengwan Zhang, 2024. "Generation mechanism of behavioral risk for organizational decision-makers in financial institutions: organizational and human errors," Palgrave Communications, Palgrave Macmillan, vol. 11(1), pages 1-10, December.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Upravitelev, A., 2023. "Neoclassical roots of behavioral economics," Journal of the New Economic Association, New Economic Association, vol. 58(1), pages 110-140.
    2. Katharina Dowling & Daniel Guhl & Daniel Klapper & Martin Spann & Lucas Stich & Narine Yegoryan, 2020. "Behavioral biases in marketing," Journal of the Academy of Marketing Science, Springer, vol. 48(3), pages 449-477, May.
    3. Daniele SCHILIRÒ, 2013. "Bounded Rationality: Psychology, Economics And The Financial Crises," Theoretical and Practical Research in the Economic Fields, ASERS Publishing, vol. 4(1), pages 97-108.
    4. Moscati, Ivan, 2021. "On the recent philosophy of decision theory," LSE Research Online Documents on Economics 115039, London School of Economics and Political Science, LSE Library.
    5. Xavier Gabaix, 2017. "Behavioral Inattention," NBER Working Papers 24096, National Bureau of Economic Research, Inc.
    6. Basel, Jörn S. & Brühl, Rolf, 2013. "Rationality and dual process models of reasoning in managerial cognition and decision making," European Management Journal, Elsevier, vol. 31(6), pages 745-754.
    7. D. Wade Hands, 2020. "Libertarian paternalism: taking Econs seriously," International Review of Economics, Springer;Happiness Economics and Interpersonal Relations (HEIRS), vol. 67(4), pages 419-441, December.
    8. Luca Congiu & Ivan Moscati, 2022. "A review of nudges: Definitions, justifications, effectiveness," Journal of Economic Surveys, Wiley Blackwell, vol. 36(1), pages 188-213, February.
    9. Beshears, John & Kosowsky, Harry, 2020. "Nudging: Progress to date and future directions," Organizational Behavior and Human Decision Processes, Elsevier, vol. 161(S), pages 3-19.
    10. Schnellenbach, Jan, 2012. "Nudges and norms: On the political economy of soft paternalism," European Journal of Political Economy, Elsevier, vol. 28(2), pages 266-277.
    11. Schnellenbach, Jan & Schubert, Christian, 2015. "Behavioral political economy: A survey," European Journal of Political Economy, Elsevier, vol. 40(PB), pages 395-417.
    12. Stefano DellaVigna, 2009. "Psychology and Economics: Evidence from the Field," Journal of Economic Literature, American Economic Association, vol. 47(2), pages 315-372, June.
    13. Aurélien Baillon & Zhenxing Huang & Asli Selim & Peter P. Wakker, 2018. "Measuring Ambiguity Attitudes for All (Natural) Events," Econometrica, Econometric Society, vol. 86(5), pages 1839-1858, September.
    14. Aleksander Rubinstein, 2013. "The theory of patronized goods in the optics of comparative methodology," International Journal of Entrepreneurial Knowledge, Center for International Scientific Research of VSO and VSPP, vol. 1(1), pages 4-32, December.
    15. Рубинштейн Александр Яковлевич, "undated". "Методологический Анализ Теории Опекаемых Благ: Научный Доклад [methodological analysis of the Theory of Patronized Goods. Research report]," Working papers a:pru175:ye:2014:1, Institute of Economics.
    16. Pavel Pelikán, 2010. "The Government Economic Agenda in a Society of Unequally Rational Individuals," Kyklos, Wiley Blackwell, vol. 63(2), pages 231-255, May.
    17. Divya Aggarwal & Pitabas Mohanty, 2022. "Influence of imprecise information on risk and ambiguity preferences: Experimental evidence," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 43(4), pages 1025-1038, June.
    18. Jacobs Martin, 2016. "Accounting for Changing Tastes: Approaches to Explaining Unstable Individual Preferences," Review of Economics, De Gruyter, vol. 67(2), pages 121-183, August.
    19. Abel , Martin & Cole, Shawn & Zia, Bilal, 2015. "Debiasing on a roll: changing gambling behavior through experiential learning," Policy Research Working Paper Series 7195, The World Bank.
    20. Christian Schubert, 2015. "On the ethics of public nudging: Autonomy and Agency," MAGKS Papers on Economics 201533, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).

    More about this item

    Keywords

    Heuristics; Biases; Bayesian rationality; ecological rationality; true uncertainty; libertarian paternalism;
    All these keywords.

    JEL classification:

    • D01 - Microeconomics - - General - - - Microeconomic Behavior: Underlying Principles
    • D04 - Microeconomics - - General - - - Microeconomic Policy: Formulation; Implementation; Evaluation
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D9 - Microeconomics - - Micro-Based Behavioral Economics

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:sae:miceco:v:7:y:2019:i:1:p:7-58. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: SAGE Publications (email available below). General contact details of provider: .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.