How does bounded rationality relate to game theory?

Bounded rationality is a concept in economics that suggests individuals have limited cognitive abilities and information processing capabilities, leading them to make decisions that are not always fully rational or optimal. Game theory, on the other hand, is a mathematical framework used to analyze strategic interactions between rational decision-makers.

Bounded rationality relates to game theory in several ways. Firstly, it recognizes that individuals may not always have complete information about the game they are playing or the strategies available to them. This limited information can affect their decision-making process and lead to suboptimal outcomes.

Secondly, bounded rationality acknowledges that individuals may not have the computational abilities to analyze all possible strategies and outcomes in a game. Instead, they rely on heuristics or simplified decision rules to make choices. These heuristics may not always result in the best possible outcome, but they allow individuals to make decisions within their cognitive limitations.

Furthermore, bounded rationality also considers the influence of emotions, biases, and social factors on decision-making. These psychological factors can impact how individuals perceive and respond to the strategic choices in a game, potentially deviating from the predictions of traditional game theory models that assume fully rational decision-making.

In summary, bounded rationality recognizes the cognitive limitations of individuals and how these limitations can affect decision-making in strategic interactions. It provides a more realistic framework for understanding human behavior in games, complementing the assumptions of rationality in traditional game theory models.