Rational and Nonrational Decision Making

Rational Decision Making

Rational decision making is a multi-step process, from problem identification through solution, for making logically sound decisions.

Learning Objectives

Explain the characteristics of the rational decision-making process

Key Takeaways

Key Points

• Rational decision making favors objective data and a formal process of analysis over subjectivity and intuition.
• The model of rational decision making assumes that the decision maker has full or perfect information about alternatives; it also assumes they have the time, cognitive ability, and resources to evaluate each choice against the others.
• This model assumes that people will make choices that will maximize benefits for themselves and minimize any cost.

Key Terms

• Rational decision making: A logical, multi-step model for choosing between alternatives that follows an orderly path from problem identification through solution.
• perfect information: A situation in which all data that is relevant to a particular decision is known and available to the decision maker.

The Process of Rational Decision Making

Rational decision making is a multi-step process for making choices between alternatives. The process of rational decision making favors logic, objectivity, and analysis over subjectivity and insight. The word "rational" in this context does not mean sane or clear-headed as it does in the colloquial sense.

The approach follows a sequential and formal path of activities. This path includes:

1. Formulating a goal(s)
2. Identifying the criteria for making the decision
3. Identifying alternatives
4. Performing analysis
5. Making a final decision.

Rational-decision-making model: This flowchart illustrates the process of rational decision making.

Assumptions of the Rational Decision-Making Model

The rational model of decision making assumes that people will make choices that maximize benefits and minimize any costs. The idea of rational choice is easy to see in economic theory. For example, most people want to get the most useful products at the lowest price; because of this, they will judge the benefits of a certain object (for example, how useful is it or how attractive is it) compared to those of similar objects. They will then compare prices (or costs). In general, people will choose the object that provides the greatest reward at the lowest cost.

The rational model also assumes:

• An individual has full and perfect information on which to base a choice.
• Measurable criteria exist for which data can be collected and analyzed.
• An individual has the cognitive ability, time, and resources to evaluate each alternative against the others.

The rational-decision-making model does not consider factors that cannot be quantified, such as ethical concerns or the value of altruism. It leaves out consideration of personal feelings, loyalties, or sense of obligation. Its objectivity creates a bias toward the preference for facts, data and analysis over intuition or desires.

Problems with the Rational Decision-Making Model

Critics of the rational model argue that it makes unrealistic assumptions in order to simplify possible choices and predictions.

Learning Objectives

Summarize the inherent flaws and arguments against the rational model of decision-making within a business context

Key Takeaways

Key Points

• Critics of the rational decision -making model say that the model makes unrealistic assumptions, particularly about the amount of information available and an individual's ability to processes this information when making decisions.
• Bounded rationality is the idea that an individual's ability to act rationally is constrained by the information they have, the cognitive limitations of their minds, and the finite amount of time and resources they have to make a decision.
• Because decision-makers lack the ability and resources to arrive at optimal solutions, they often seek a satisfactory solution rather than the optimal one.

Key Terms

• Rational choice theory: A framework for understanding and often formally modeling social and economic behavior.
• bounded rationality: The idea that decision-making is limited by the information available, the decision-maker's cognitive limitations, and the finite amount of time available to make a decision.
• satisficer: One who seeks a satisfactory solution rather than an optimal one.

Critiques of the Rational Model

Critics of rational choice theory —or the rational model of decision-making—claim that this model makes unrealistic and over-simplified assumptions. Their objections to the rational model include:

• People rarely have full (or perfect) information. For example, the information might not be available, the person might not be able to access it, or it might take too much time or too many resources to acquire. More complex models rely on probability in order to describe outcomes rather than the assumption that a person will always know all outcomes.
• Individual rationality is limited by their ability to conduct analysis and think through competing alternatives. The more complex a decision, the greater the limits are to making completely rational choices.
• Rather than always seeking to optimize benefits while minimizing costs, people are often willing to choose an acceptable option rather than the optimal one. This is especially true when it is difficult to precisely measure and assess factors among the selection criteria.

Prospect Theory

Alternative theories of how people make decisions include Amos Tversky's and Daniel Kahneman's prospect theory. Prospect theory reflects the empirical finding that, contrary to rational choice theory, people fear losses more than they value gains, so they weigh the probabilities of negative outcomes more heavily than their actual potential cost. For instance, Tversky's and Kahneman's studies suggest that people would rather accept a deal that offers a 50% probability of gaining $2 over one that has a 50% probability of losing$1.

Bounded Rationality

Other researchers in the field of behavioral economics have also tried to explain why human behavior often goes against pure economic rationality. The theory of bounded rationality holds that an individual's rationality is limited by the information they have, the cognitive limitations of their minds, and the finite amount of time they have to make a decision. This theory was proposed by Herbert A. Simon as a more holistic way of understanding decision-making. Bounded rationality shares the view that decision-making is a fully rational process; however, it adds the condition that people act on the basis of limited information. Because decision-makers lack the ability and resources to arrive at the optimal solution, they instead apply their rationality to a set of choices that have already been narrowed down by the absence of complete information and resources.

Non-Rational Decision Making

People frequently employ alternative, non-rational techniques in their decision making processes.

Learning Objectives

Examine alternative perspectives on decision making, such as that of Herbert Simon and Gerd Gigerenzer, which outline non-rational decision-making factors

Key Takeaways

Key Points

• The rationality of individuals is limited by the information they have, the cognitive limitations of their minds, and the finite amount of time they have to make a decision.
• Simon defined two cognitive styles: maximizers and satisficers. Maximizers try to make an optimal decision, whereas satisficers simply try to find a solution that is "good enough" for the situation.
• Some research has shown that simple heuristics frequently lead to better decisions than the theoretically optimal procedure.
• Emotion appears to aid the decision-making process; decisions often occur in the face of uncertainty about whether one's choices will lead to benefit or harm.
• Robust Decision Making (RDM) is a particular set of methods and tools that is designed to support decision making under conditions of uncertainty.

Key Terms

• rational: Logically sound; not contradictory or otherwise absurd.
• heuristic: An experience-based technique for problem solving, learning, and discovery; examples include using a rule of thumb, an educated guess, an intuitive judgment, or common sense.
• cognitive: The part of mental functions that deals with logic, as opposed to affective functions, which deal with emotion.

The rational model of decision making holds that people have complete information and can objectively evaluate alternatives to select the optimal choice. The rationality of individuals is limited, however, by the information they have, the cognitive limitations of their minds, and the finite amount of time they have to make a decision. To account for these limitations, alternative models of decision making offer different views of how people make choices.

Herbert A. Simon

American psychology and economics researcher Herbert A. Simon defined two cognitive styles: maximizers and satisficers. Maximizers try to make an optimal decision, whereas satisficers simply try to find a solution that is "good enough." Maximizers tend to take longer making decisions due to the need to maximize performance across all variables and make trade-offs carefully. They also tend to regret their decisions more often (perhaps because they are more able than satisficers to recognize when a decision has turned out to be sub-optimal). On the other hand, satisficers recognize that decision makers lack the ability and resources to arrive at an optimal solution. They instead apply their rationality only after they greatly simplify the choices available. Thus, a satisficer seeks a satisfactory solution rather than an optimal one.

Gerd Gigerenzer

German psychologist Gerd Gigerenzer goes beyond Simon in dismissing the importance of optimization in decision making. He argues that simple heuristics—experience-based techniques for problem-solving—can lead to better decision outcomes than more thorough, theoretically optimal processes that consider vast amounts of information. Where an exhaustive search is impractical, heuristic methods are used to speed up the process of finding a satisfactory solution.

The Brain's Heuristics for Emotions: Emotions appear to aid the decision-making process.

The Role of Emotion

Emotion is a factor that is typically left out of the rational model; however, it has been shown to have an influential role in the decision-making process. Because decisions often involve uncertainty, individual tolerance for risk becomes a factor. Thus, fear of a negative outcome might prohibit a choice whose benefits far outweigh the chances of something going wrong.

Robust Decision Making

Robust decision making (RDM) is a particular set of methods and tools developed over the last decade—primarily by researchers associated with the RAND Corporation—that is designed to support decision making and policy analysis under conditions of deep uncertainty. RDM focuses on helping decision makers identify and develop alternatives through an iterative process. This process takes into account new information and considers multiple scenarios of how the future will evolve.