Definition
Bounded rationality, a concept introduced by Herbert Simon, holds that people are rational but only within real-world limits. They cannot gather every fact, compute every outcome, or anticipate every consequence, so they reason as well as their constraints allow rather than as a flawless optimizer would.
The idea revises the classical assumption of a perfectly informed, perfectly calculating economic agent. Instead of maximizing, boundedly rational actors often satisfice — they search until they find an option that is good enough and then stop.
Why it matters
How it works
Facing complexity, people simplify. They use rules of thumb, anchor on familiar reference points, weigh vivid information more heavily than statistics, and default to the status quo. These shortcuts conserve scarce cognitive effort and usually serve well enough.
The same shortcuts also create systematic biases that markets can amplify — herd behavior, overconfidence, and loss aversion all trace back to bounded rationality. Behavioral economics builds on this foundation, and choice architecture applies it by shaping the environment in which bounded decisions are made.