BOUNDED RATIONALITY
Bounded rationality is the notion that rationality is limited, when individuals make decisions, by the tractability of the decision problem, the cognitive limitations of the mind, and the time available to make the decision. In essence, what bounded rationality implies is that no human is 100% rational when making a decision in a real-world scenario.
A prime example in the domain of bounded rationality would be a business owner choosing a bank to transact his or her business. This could seem like an easy decision as one would tend to flock towards the best bank there is but the decision is hindered by a variety of factors such as home bias, placebos, intuitions, information asymmetry, emotions, etc.
MAJOR FACTORS GOVERNING HUMAN DECISION MAKING
HOME BIAS: One of the most prominent factors in decision making is home bias. An individual with even the tiniest bit of patriotism or a feeling of belongingness towards a particular country or region would give preference to the products manufactured in that region. A prime example would be the Swadeshi Movement in India in the first decade of the twentieth century. The Swadeshi Movement promoted the sale of goods that were manufactured in India by Indian citizens and boycotted the purchase of foreign goods that were being exported to India by the British during the British Raj. The Swadeshi Movement played a huge role in the freedom struggle and this was only possible because people started purchasing Indian goods which promoted the Industrial Revolution in India. The Movement continues to this day and has been renamed as the “Make in India” campaign.
GOLDEN HAMMER: A golden hammer can be described as one of those cures that are thought to be universal but are not so in reality. It is a situation where all the problems seem like a nail and all you have is a hammer so you decide to wield the same hammer to solve every problem. In marketing, the demographic from the age group of 18–34 is treated as the golden hammer, meaning all the products to be manufactured should be catering to the needs of this demographic primarily. Though the age group from 18–34 is very large and influential, relying solely on just one demographic without significant market research is preposterous. Golden Hammers exist mainly in the form of standard practices, customary analytics, traditional approaches, or what experts say.
EMOTION: Another major determinant of decision making are emotions. I would like to explain this with a few examples. Lets’s assume a child in India wants to buy a bat, a completely rational assumption if I may say so, he goes to the store with his dad and asks for an MRF bat. This makes the store owner and the employees chuckle as MRF is a tyre company and doesn’t manufacture bats but the child is adamant on buying an MRF bat. He doesn’t want to buy any other bat no matter the quality of the willow. Upon being asked as to why he would want to buy an MRF bat compared to other bats, the child replies “Virat Kohli plays with an MRF bat and he is my favourite cricketer”. The child doesn’t know that MRF doesn’t manufacture bats, rather he doesn’t want to know that fact. All he wants is an MRF labelled bat. This is solely governed by emotions rather than the rationality of the consumer. Some people tend to buy articles of a certain colour or number because they consider them lucky or hold some values to them which is an example of a person’s psychological make-up.
INTUITION: Intuition play a key role in investing. In most scenarios, even if the trends of a particular stock look good and the stock is known to be fairly stable a person might not invest in it and the reason might simply be a gut-feeling. On the other hand, a falling knife may sometimes be invested in even with the knowledge of the nature of the investment being risky simply because of intuition. Such factors are hard to explain but such are the quirks of the human mind.
CONCLUSION
As we conclude it is noteworthy to observe that in some cases we choose to be bounded rationally i.e. we make a choice knowing that we might be missing out on some information. This may well be because of emotions and intuitions but after all, that is exactly what makes us human and further encourages us to study behavioural patterns in decision making and finance.
