Distinguished Speaker Series
Friday, January 18, 2013
10:30AM - 12:00 PM
The Paul Merage School of Business, Room 112
Roy Radner, Leonard N. Stern Professor Business, New York University
Dr. Roy Radner is Leonard N. Stern School Professor of Business and Professor of Economics, Information Systems, and Environmental Studies, at New York University. Prior to joining New York University, he was a Distinguished Member of Technical Staff at AT&T Bell Laboratories, and Professor of Economics and Statistics at the Univ. of Calif., Berkeley. Dr. Radner's current research interests include the strategic analysis of global climate change, bounded rationality in decision making, and pricing of information technology. He is a member of the National Academy of Sciences of the U.S., a Fellow of the Amer. Acad. of Arts and Sciences, a Distinguished Fellow of the Amer. Assoc. for the Adv. of Sci. and of the Amer. Economic Assoc., a Past-President of the Econometric Society, an Overseas Fellow of Churchill College, Cambridge, and a past recipient of a Guggenheim Foundation Fellowship.
Title of talk: Bounded Rationality: In Search of a Definition, with an Application
In the term "bounded rationality,” the word “bounded” is apparently an adjective modifying the work “rationality.” In this talk I adopt the view that the term "bounded rationality” is concerned with how "smart" decision-makers deal with “bounded cognition,” i.e., cognitive limitations that preclude fully rational procedures in the sense of (say) L. J. Savage. This is in the spirit of the work of H. A. Simon, J. Marschak, and also, to some extent, Savage himself. Thus I see the topic as a subfield, but only a proper subfield, of what has come to be called "behavioral economics" (or the equivalent in psychology and sociology). I shall here confine my attention to situations with a single decision-maker, leaving it to other occasions to deal with games, markets, and evolution. After a brief review of the Savage paradigm, I review in that context the problems raised by various aspects of bounded cognition, and various suggested models of corresponding behavior. A few of these models seem promising as being relevant to some concept of “rationality,” but none successfully addresses the cognitive limitation of the “failure of logical omniscience.”
As an example, I present a model of dynamic monopoly pricing for a good that displays network effects. In contrast with the standard use of a rational-expectations equilibrium to model demand for a network good, we model consumers as boundedly rational, and unable either to pay immediate attention to each price change, or to make accurate forecasts of the adoption of the network good. Our analysis shows that the seller's optimal price trajectory has the following structure: the price is low when the user base is below a target level, is high when the user base is above the target, and is set to keep user base stationary once the target level has been attained. We show that this pricing policy is robust to a number of extensions, which include the product's user base evolving over time, and consumers basing their choices on a mixture of a myopic and a "stubborn" expectation of adoption. Our results differ significantly from those that would be predicted by a model based on rational-expectations equilibrium, and are more consistent with the pricing of network goods observed in practice.