Decision making in uncertainty: beyond calculation, the role of imagination and judgment

The traditional decision-making model, rooted in the ideal of the rational actor calculating the best decision with perfect information, is increasingly inadequate in our complex, uncertain world. When information is scarce or inadequate, judgment and imagination must be used instead.

The standard model of decision making is the rational actor model (RAM). In this model, the decision maker is a calculator and an optimizer: he or she has all the available information and makes the best possible decision based on it. The decision made is objectively the best possible decision, and another agent would have made the same decision. This model has been widely criticized for its unrealistic assumptions. Among other things, the idea that the decision maker has all the available information is never true in practice. This is what we call bounded rationality: decisions are always made with a very small amount of information.

Indeed, gathering all this information is costly and time-consuming. As a result, when it comes to making a decision, the decision maker must decide whether to continue searching for information or to stop. Decision making is therefore a process, not an instant, and there is a trade-off to be made: more information might improve the quality of the decision (but not necessarily so), but it would delay it and eventually render it useless. Nobel laureate Herbert Simon, who has written extensively on decision making, moves away from this purely theoretical model to qualify the more realistic approach with the word “satisficing,” meaning that the decision is made when we have found a satisfactory solution, not knowing whether a better one could be found if we kept looking for more information.

This is something we all do: when we buy a house, we don’t visit every house in the world before we make our choice. We’ll select a few in a region and visit only a few after eliminating the others with a phone call. It’s rational not to consider all the information available, and besides, we’ll only be able to choose from the houses that are for sale at the time. If we broaden our search and delay our decision, some will be sold and no longer available to us, while others will become available simply by waiting. In the end, the house we buy is not the optimal choice in absolute terms, but in relation to the sample from which we were able to choose at a given time.

The introduction of time into the model, as you will have noticed, brings with it some important changes. If there is time, there is a future; and the nature of the future is to bring new information in a kind of continuous stream, no matter what we do. In the example of the house, time allows some houses to disappear from the market (the absence of a decision on our part leaves the field open for another buyer) and others to appear (those put on the market). Time can also bring about changes in, for example, taxation or interest rates, making our purchase easier or more difficult.

Therefore, as soon as we include time in the decision model, we know that the decision maker, who is deciding at the present moment, can never have all the information needed to make his decision. Due to the existence of the future, more information will always be available. Consequently, a decision is always made with a (rather small) subset of all theoretically possible information. We’d have to wait indefinitely for all the information to be available, and even then we’d never make a decision, or we’d make it too late.

The first person to recognize the importance of time was the economist Richard Cantillon. By observing entrepreneurs, he understood the specific nature of their activity: essentially, entrepreneurs incur expenses in the present (by hiring employees and buying equipment and raw materials), the cost of which is known, in order to sell products in the future, in quantities and at a price they cannot know in advance. There is thus a time-dependent trade-off, or arbitrage, which is the specificity of entrepreneurial activity (and which makes all market activity speculative). Frank Knight, an economist, developed this idea. He suggested that entrepreneurs solve Cantillon’s problem not by calculation but by judgment, i.e. a subjective (somebody might make another one) and circumstantial (it might be different another time) assessment that enables them to form an opinion. It is only through their judgment that entrepreneurs can define prices and expected quantities; it is this judgment that, if successful, is rewarded by profit (as we can see, this analysis of the source of profit as a reward for uncertainty management differs significantly from Marx’s).

Imagination and judgment

The importance of time in decision-making has been studied in detail by another economist, George Shackle, who has remained rather obscure despite his fundamental contribution. Shackle points out that the presence of time necessitates decision-making with limited information, emphasizing that these decisions rely more on imagination than complete data, as much of the necessary information pertains to the yet-to-unfold future. He observes that once we reject the idea of a deterministic, pre-written future, we can conceive of decision-making as a new beginning, as if we were opening a new path in relation to the stream of events that would unfold if the decision were not made. Without the decision, the future is A; with the decision, it becomes B. This decision is the result of imagination, insofar as it has no other cause, otherwise it would be tantamount to reintroducing determinism. It is therefore a “cause” (because its consequence is to create a new future in the sense that it has consequences – to create future B instead of letting future A happen) but “uncaused” (other than our imagination). As we can see, imagination is closely related to decision-making in the face of uncertainty, which is no longer a matter of calculation in the presence of perfect information. Decision-making thus becomes a creative art in which we invent something that didn’t exist before based on our imagination or judgment, neither of which is reducible to calculation.

This creative dimension of decision making under uncertainty is reflected in effectuation, which is the reasoning logic of entrepreneurs. It corresponds to the fifth principle of effectuation, “the pilot in the plane”, which states that the future depends on what we do; it is the consequence of our actions. It allows us to assert that entrepreneurs don’t discover the future, but co-create it through their actions: the stream of future events is always (at least partially) indeterminate at the moment a decision is made, and that decision, combined with those of millions of other actors, will necessarily modify that stream and thus the future.

➕ On Franck Knight, read my article: Frank Knight’s century-old wisdom on risk, uncertainty, and profit.

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🇫🇷 French version of this article here.