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While traditional economics assumes that humans are fully rational
agents who always maximize their expected utility, in practice, we
constantly observe apparently irrational behavior. One explanation is
that people have limited computational power, so that they are, quite
rationally, making the best decisions they can, given their
computational limitations. To test this hypothesis, we consider the
multi-armed bandit (MAB) problem. We examine a simple strategy for
playing an MAB that can be implemented easily by a probabilistic finite automaton (PFA).
Roughly speaking, the PFA sets certain expectations, and plays an arm
as long as it meets them. If the PFA has sufficiently many states, it performs near-optimally. Its performance degrades gracefully as the number of states
decreases. Moreover, the PFA acts in a ``human-like'' way,
exhibiting a number of standard human biases, like an optimism
bias and a negativity bias.
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