Bounded Rationality in Industrial Organization

John von Neumann and Oskar Morganstern ... Unfortunately, at the time of writing this
article I had no opportunity of obtaining a copy of this important book.”
One tends to think that there was a long era of neoclassical dominance betweeen the
death of this old literature and the birth of interest in post-rationality bounded rationality.
In this light, I find it noteworthy that less than a decade separates the publication of
Rothschild’s paper and the publication of Simon’s (1955) “A Behavioral Model of Rational
Choice.” Simon is clearly writing for an audience steeped in rationality and sells his bounded
rationality as an enhancement of the prevailing paradigm:
the task is to replace the global rationality of economic man with a kind of
rational behavior that is compatible with the access to information and the
computational capacities that are actually possessed by organisms.
Simon discusses the various challenges involved in optimization. His critiques and visions for
a new framework are compelling. The progress he makes toward this goal is less satisfying.
He mostly ends up emphasizing a “satisficing” model in which agents search for actions
until they find one that achieves a payoff that provides them with at least some aspiration
level.
Cyert and March (1956) is an early application to industrial organization. In the modern
style, they start by citing interesting papers from the psychology literature to justify
their assumptions about deviations from profit-maximization. 1 Among the implications of
satisficing they discuss are that firms are most likely to expand sales when profits are low
and costs high, and that dominant firms may tend to lose market share over time. The
analytic methodology, of course, is still far from modern: other than one set of diagrams
using Stigler’s dominant firm model, the analysis is completely informal. They do present
empirical data related to their hypotheses.
One aspect of this literature that is striking in contrast to the current literature is that
the focus is almost exclusively on firms’ deviations from profit-maximization rather than
on consumer irrationality. Indeed, consumers are rarely mentioned. Their presence is, of
1 For example, the notion that people satisfice is supported by the experiments showing that subject who
are asked to throw darts as close to the center of a target as possible are more accurate when the target is
smaller.
4