Bounded rationality, an idea first introduced by Herbert Simon, refers to the obvious fact that human cognitive abilities are not infinite.8 We have limited computational skills and seriously flawed memories. People can respond sensibly to these failings; thus it might be said that people sometimes respond rationally to their own cognitive limitations, minimizing the sum of decision costs and error costs. To deal with limited memories we make lists.
To deal with limited brain power and time we use mental shortcuts and rules of thumb. But even with these remedies, and in some cases because of these remedies, human behavior differs in systematic ways from that predicted by the standard economic model of unbounded rationality. Even when the use of mental shortcuts is rational, it can produce predictable mistakes. The departures from the standard model can be divided into two categories: judgment and decisionmaking. Actual judgments show systematic departures from models of unbiased forecasts, and actual decisions often violate the axioms of expected utility theory.
A major source of differences between actual judgments and unbiased forecasts is the use of rules of thumb. As stressed in the pathbreaking work of Daniel Kahneman and Amos Tversky, rules of thumb such as the availability heuristic—in which the frequency of some event is estimated by judging how easy it is to recall other instances of this type (how “available” such instances are)—lead us to erroneous conclusions. People tend to conclude, for example, that the probability of an event (such as a car accident) is
greater if they have recently witnessed an occurrence of that event than if they have not.9 What is especially important in the work of Kahneman and Tversky is that it shows that shortcuts and rules of thumb are predictable. While the heuristics are useful on average (which explains how they become adopted), they lead to errors in particular circumstances. This means that someone using such a rule of thumb may be behaving rationally in the sense of economizing on thinking time, but such a person will nonetheless make 8. Herbert A. Simon, A Behavioral Model of Rational Choice, 69 Q.J. ECON. 99 (1955) 9. Amos Tversky & Daniel Kahneman, Judgment Under Uncertainty: Heuristics and Biases, in JUDGMENT UNDER UNCERTAINTY 3, 11 (Daniel Kahneman, Paul Slovic & Amos Tversky eds., 1982).
1478 STANFORD LAW REVIEW [Vol. 50:1471 forecasts that are different from those that emerge from the standard rationalchoice