Decision Making and Cognitive Biases

This assignment delves into the concept of bounded rationality and its influence on human decision-making processes. It examines various cognitive biases that can distort judgments and lead to suboptimal outcomes. The assignment encourages critical analysis of academic literature on topics such as framing effects, overconfidence bias, and escalation of commitment. Students are expected to synthesize information from provided sources and demonstrate an understanding of how these biases manifest in real-life situations.

Running head: RATIONAL BEHAVIOR
Simon’s principle of Bounded Rationality
Name of the Student
Name of the University
Author Note

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Part 1- Essay
Herbert Simon who was the US Nobel-laureate economist suggested in this book
‘Models of bounded rationality and other topics in economics’ that the concept of bounded
rationality is that decision makers regardless of their level of intelligence have to function
under three inevitable constrains (Harstad & Selten, 2013). However, at times only limited
and unreliable information are available without any possible alternatives and their outcome,
humans have only limited capacity in their mind to assess and handle the available
information. Lastly, very little time is thus obtainable to make a decision. Moreover,
individuals who have plans to make rational choices are having certain limits to their choices
that are sacrificing in complex situations. However, these limitations in rationality also make
it impossible to pull up contracts that involve every incident that is necessitating reliance on
the rule of thumb. Simon, through his work always wanted to make a theory of human
behavior (Katsikopoulos, 2014).
Humans are never faultless in decision-making. Simon in his work actually stated that
decisions are limited in the rationality. As far as the framework of bounded rationality is
concerned, human beings always tries to make decisions rationally however, the cognitive
limitations in humans restrict them from being rational fully (Achtziger et al., 2012). Time
and cost restrict the quantity and quality information that is available to the individuals.
Humans only keep a comparatively small amount of information in the human functional
memory. However, the boundaries on intelligence and perceptions forces the ability of bright
decision makers to make the better choice based on the already available information.
Simon’s concept of the bounded rationality explains that judgment diverge from rationality
but it does not clearly explains that how judgment is biased. However, Tversky and
kahneman’s research in 1974, helped to identify the particular organized, directional biases

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that influence the human judgment (Scheufele & Iyengar, 2012). However, these biases are
generated by the propensity to short-circuit a rational decision making process by depending
on a number of rationalize strategies, or rules of thumb that is known as Heuristics.
Judgment in decision-making however is ability, capacity or faulty to build considerable
and effective decisions, reach effective conclusions, understand and distinguish relationships,
comprehend the situations and form objective options mostly in those matters that affect
actions (Manktelow, 2012).
Thus, in the context of decision-making judgment can be outlined as the potential to
decide, the thought procedure that is used to decide and lastly, that result of the decision that
comes from employing judgment (Kaplan, 2013). The judgment and decision making
according to the research goal of Simon is all about how to make better decisions. However,
both of these concepts are very much interlinked in individual’s daily life. In every situation,
individual’s minds are susceptible to make judgments and choose various options and choices
for decision-making. Thus, the outcome of this human judgment is choice. For every situation
or problems, every human mind has different solution that is uniquely thought. These various
solutions are cognitive evaluations are that is solely based on the reality and confirmation of
their alternatives and based on which the outcome that is delivered is their judgment. For
instance, during the senior year in the college on individual applies to a number of doctoral
courses, law and business schools. However, he receives acceptance letters from a majority of
them. So here, the judgment and decision-making would be applicable. Bazerman and Moore
2013 stated that there are six steps so that a rational decision making can be reached and they
are first, to recognize the problem, then to spot the necessary criteria to decide the various
options (Basel & Brühl, 2013). Followed by ranking the criteria’s in order to see the
importance, initiate alternatives, rating the alternatives on each of the criterions and lastly,
calculate the optimum decision.

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Overconfidence is the usual habit of overrating the validity of the individual
knowledge, their ability and other related fields. Thus, overconfidence is collected of other
cognitive failures such that those that is more strenuous to prevent. While overconfidence is
nearly continually detrimental as a choice of lifestyle, creating an optimistic overview, which
satisfies one’s health along with making the making the individual, seems more prosperous.
However, this might cause many foolish decisions throughout the lifetime (Hilbert, 2012).
Human mind can vary hugely in their awareness of what they know and they do not or their
metacognitive ability and thus are generally too confident when assessing their performance.
However, this very often guides to poor decision making with possibly disastrous outcomes.
Overconfidence mainly acts as a bias in decision making when an individual places too much
of belief in their own knowledge and choices. This might lead to a contribution of decision to
be more valuable than it really is. Albert and Raffia first revealed the overconfidence bias in
1969 (Paluch, 2012). The theory, which revolves around the cognitive bias in decision-
making, can be detected back by Herbert Simon who went against the rational economic
thoughts to suggest the judgment, which is fact, bound in its intellect.
In overconfidence, the other phenomenon is the overrated of the accuracy of the
knowledge that guides managers to become excessively optimistic about the convenient
outcomes. Hilton et al. 2011 considered Moore and Healy’s definitions for the
overconfidence in describing three types of overconfidence (Glaser, Langer & Weber, 2013).
However, those are overestimating the accuracy of individual’s knowledge, overrating the
quality of individuals performance and overvaluing individual ranking in a group called over
precision, overestimation and overpayment respectively. Overconfidence is an exceedingly
relevant bias for the leaders in maximum of the industries. It can however, influence behavior
on financial markets which is developing the time and budgets to finish projects, and
common strategic managerial decision-making (Cutler, 2013). However, it is often used to

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made people understand that high rate of investment in combination and attainments given
the huge historical data that is showing that such ventures usually fails. As it can be said, that
decision-making is the importance of the individual’s ability and judgment for delivering the
outcome, the individual should be confident in making the decision. The decision-making can
cause success as well failure, but overconfidence in the decision making process can cause
bias in this process that may lead to minimizing accuracy of decisions.
Escalation of commitment takes place when an individual continues to inscribe
resources involving time as well as money to some faulty course of action. However, this is
another distortion that crawls into decisions in practice that is escalated in the decision stream
representing a series of decisions. Escalation of commitment can be defined to stay with a
decision even if there is clear confirmation that it is wrong. It however, has obvious
implications for the managerial decisions. Organizations usually suffers loses because of the
managers determination to prove their original decision was correct by remaining to commit
resources to what was a lost that has been caused from the beginning. Moreover, managers in
an attempt to appear effective may get motivated to be steady when shifting from another
course of action, which is preferable to them. Escalation of commitments however, is
congruent with evidence that people try to materialize consistently in what they say they will
do. The growing commitments to the individual’s previous actions transfer consistency
(Sleesman et al., 2012).
Thus, from an organization’s prospective it can be said that escalation of commitment
occurs when an individual invest resources into a failing course of action. The resources can
be time, money and energy. These are mainly used in an investment because no one wants to
be appeared as inconsistent. Researchers have stated many related theories to define the
inclination of humans to escalate their commitments towards some undesirable choices if
they have spent resources in these attempts. The theories are mental accounting, inference of

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commitment or ownership, justification of the behavior, self-affirmation and justification of
the behavior, prospect theory, rule governance and construal of the future. However, to
restraint escalation of commitment, employees or the managers must discuss some of the
values that they share. Then only each individual will discuss why one or more of the values
are important. This exercise is however, known as self-affirmation that will have a tendency
to restrict escalation of commitment. Escalation of commitment partially arises because
individuals do not that they have wasted the resources. They believe to feel that their past
courses of actions were valuable (Kelly & Milkman, 2013).
Thus, it can be concluded that Herbert Simon who has given the concept of rational
behavior however streams into the problem solving behavior of the human mind. Human
mind is not capable of solving all the problems as their capacity for solving the problems are
very small in comparison with the size of the problems whose solution is needed. However,
there are three discrete concepts that act as a bias in the decision-making and they are
judgment, overconfidence and escalation in commitment in the sphere of decision-making.
However, in judgment and decision making the emphasis is on the ways in which the
individual departs from the rational and ethical standards in a group or organizational
situation. Overconfidence is the biased way of viewing a situation and lastly, escalation of
commitment states to the individual behavior patterns in which the person or group if faced
with growingly negative results from some decision, action or the investment are found
continuing with the same old behavior than changing the course.

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Part 2- Case study
The decision-making is an important part in running a business enterprise, which
countenance a large number of problems that is required for taking a decision. However, five
steps are required for managerial decision-making processes are- inaugurating the objective
that is in a private enterprise is maximizing profit or sale growth as far the organizational
need. Then follows the definition of the problem in which the nature of the problem is so that
proper solution can be given. Alternative solutions are identified that is identification of the
variables that are having an influence on the problem and then, relevant data is collected.
Lastly, executing the decision that has been taken following all the steps. In this part of the
essay, the discussion will be on the real life scenarios of Judgments, overconfidence and
escalation of commitment biases in real life scenario (Hartman, DesJardins & MacDonald,
2014).
Judgment and decision making in real life scenario
The judgment bias of decision-making relies on three judgmental heuristics that
guides to a number of biases in the decision making process which are Representativeness,
Availability and Anchoring. However, these heuristics at times seriously affect the judgment.
Psychologists Tversky and kahneman in the 1970 defined this concept of representative
heuristic is a decision making cutoff the employs the uses of their experiences to lead the
decision making process (Kearney, 2013). The meaning of the word ‘representativeness’ here
is used in the context to the notion that when one is confronted with any fresh experience and
needs to make a judgment or take a decision about any situation, the human brain
automatically goes back to the past experiences. Moreover, the mental representations that
seemingly is similar to the new situation in an attempt to guide the judgments’ and decisions.

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However, relying solely on one’s past experiences can be advantageous and allow for quicker
conclusions that are to be reached (Gold, Colman & Pulford, 2014).
The representative heuristics plays an important role in the real life decision making
and judgments’ providing scenarios as well (Kralik et al., 2012). For instance if the topic of
crime is taken from our very known factors I can say that if a person is summoned of
abducting a child for payment can be more believable to be guilty in compare to the one who
may kidnap an adult for no payment. Thus, in the situation both crimes are coming under
kidnapping but the more representative example is the first one according to me as who is
asking for the payment better fits with the thinking of most common people when they hear
about kidnapping. Therefore, it will also make my judgment bias while making a decision
between both the cases as my concept of kidnapping like all others is related to a ransom they
will ask for after kidnapping. Heuristics however, plays an important role in the evaluations
we make about the other people. We tend to evolve the ideas that people in certain roles will
behave in a particular manner (Blumenthal-Barby & Krieger, 2015). Therefore, in real life we
often try to view as if for example a farmer must be hard working, outdoor and tough.
Whereas, we view a librarian as quiet, orderly and reserved. Thus, how well a person can fits
into these representations of these professions influence our views of how likely it is that they
hold one of these viewpoints.
Overconfidence in real life scenario
Overconfidence bias is when the confidence of an individual way to overconfidence
and this will in away transform from being an asset to a accountability (Zaidi & Tauni,
2012). This is an absolute bias in which an individual’s subjective confidence in their
judgments is faithfully greater than the objective correctness of those judgments’ mainly
when confidence is comparatively high. This can actually cause an individual to experience
problems as they may not be prepared properly for a condition or may be caught in a

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dangerous situation that they are not prepared to handle (Koellinger & Treffers, 2012).
However, in real life situations overconfidence bias are seen to affect both the corporate
circumstances and individual speculations. In real life, situations also there are a tendency
where overconfidence actually makes a bias in decision-making. One example that I had gone
through is from 2010 the US dollar was continuously increasing. Due to the continuous
increase in the US dollar price, I was so overconfident that I thought in future also it would
only increase. Having faith in my thought, which was actually my over confident I started
buying more US dollars blindly and suddenly in 2014, the prices fall (Risen, 2014). Thus, this
has made me involve in such a situation that I was never prepared for and neither did I
thought that I was being over confident and it can be a bias in my decision making procedure.
However, it was often seen that due to repeated increase in gold prices people use to
invest in gold but after October 2012 the prices of the gold started falling and then people
realized how overconfident they were when making the decision of investing in gold.
Another very common example in real life can be the Stock market crash in 1929 that is the
most important crash in the history of United States. Until 1922 the stock market has only
increased and never came down that is nearly 20% a year but when the stock market suddenly
crashed the brokers started calling for a loans (Esping-Andersen, 2017). Maximum of the
people were let out completely, selling their businesses and losing all of their life savings. In
our daily life I have a friend who I remember went out on a long trip without a road map
showing overconfidence that we all not that he is not at all good with roads. He was also
refusing to ask people for directions and thus, fell into a huge trouble.
Escalation of Commitment in real life scenario
This kind of bias is said to happen when someone sustained to devote resources that
involve both time and money to an imperfect course of action. However, escalation of
commitment is a usual practice both in the daily professional as well as personal life of

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people (Woods, Dalziel & Barton, 2012). Therefore, if an investor buys stock expecting that
the price will increase and then pursue to buy more and more as the price decrease, thus they
are escalating their commitment. This happens because the original plan was not this, they
were to invest $10,000 but they lastly end up investing more in strive to make their original
decision right. Escalation of commitment bias can also be defined by the reasoning of people
who enjoys the lottery. However, escalation of commitment is a tendency of having made a
decision to stick with it in the face of clear evidence that it is a bad call. However, this
continuation of losing a course of action is actually the escalation of commitment. Therefore,
it can be said that it is a kind of addiction knowing very well about the consequences
(Drummond, 2014).
From my personal experience, what I have been through because of escalation in
commitment bias is what I would like to share. Not long back like many people I got this
habit of buying lottery tickets or scratchers because I have this idea that I stand a chance to
win even if the odds are not in my favor. However, if people lose repeatedly and their money
dwindles slowly they are still found driving back to the stores to get another ticket with the
feeling that they will definitely going to win this time. This is what happened to me, I was
giving up all my money in the hope that I will win this one or the next. If people think
logically about this lottery concept then they will realize that odds are not in anyone’s favor
and it is because of that the sum of money that could be won is so huge. However, while I
was into it there seemed to logic working for me and so I was only attracted to the huge
money and taking chances blindly. Thus, this large amount of money forces the individual to
put their logics aside and makes the person addictive in purchasing the lottery, hoping to be
the next winner. Therefore, for me this is how escalation of commitment bias took place.
Therefore, to conclude this case study it can be said that the applications of the
concept of representative judgment bias, overconfidence bias and escalation of commitment

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is discussed in relation to the real life scenario. However, it is seen that all of these concepts
very much affect our decision making but if these facts and then use these in our real life
situations then only the decisions can provide better feedbacks and more precise and also
move forward with the theory that Simon defined. Decision-making however can be defined
as an important part in running a business enterprise, which countenances a large number of
problems that is required for taking a decision. Therefore, as can be seen from the case study
that the discussion on these biases actually makes a great deal of difference in both the
personal as well as professional life.

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