In Models of Man, Herbert Simon points out that most people are only partly rational, and are emotional and/or irrational in the remaining part of their actions. In another work, he states bounded rational agents experience limits in formulating and solving complex problems and in processing information. Simon describes a number of dimensions along which classical models of rationality can be made somewhat more realistic, which sticking within the vein of fairly rigorous formalization. These include: limiting what sorts of utility functions there might be… recognizing the costs of gathering and processing information…and the possibility of having a vector or multi-valued utility function.

Simon further suggests that economic agents employ the use of heuristics to make decisions rather than a strict rigid rule of optimization. They do this because of the complexity of the situation and their inability to process and compute the expected utility of every alternative action. Deliberation costs might be high and there are often other, concurrent economic activities also requiring decisions.

INFORMATION ASYMMETRY

Information asymmetries and incomplete markets may result in economic inefficiency but also a possibility of improving efficiency through market, legal, and regulatory remedies. From a contract theory where decisions in transactions in which one party has more or better information than the other is an asymmetry. This creates an imbalance of power in transactions which can sometimes cause the transactions to go awry. Examples of this problem are adverse selection and moral hazard. Most commonly, information asymmetries are studied in the context of principal-agent problems.