mental models

principle of optimism

"All evils are caused by insufficient knowledge." According to David Deutsch, there is no fundamental barrier, no law of nature or supernatural decree, preventing progress. Whenever we try to improve things and fail, it is not because the spiteful (or unfathomably benevolent) gods are thwarting us or punishing us for trying, or because we have reached a limit on the capacity of reason to make improvements, or because it is best that we fail, but always because we did not know enough, in time.

thought experiments

"Devices of the imagination used to investigate the nature of things." Many disciplines (e.g., philosophy and physics) make use of these to examine what can be known and open up new avenues for inquiry and exploration. They help us learn from our mistakes and avoid future ones, let us take on the impossible, evaluate the potential consequences of our actions, and re-examine history to make better decisions.

the humility question

"How might I be wrong?"

sleep-test ethics

A "starting point" ethical approach that if you can sleep well after making a difficult ethical decision, you've probably made the right choice. Offers a compelling alternative to long, cerebral, often-frustrating searches for the right grand principles. Unfortunately, our instincts are distorted by our individual wants and needs, the context/environment, and the pressures/demands of an organization, and this approach offers little guidance for "right-versus-right" dilemmas.

margin of safety

A buffer built into a system meant to reduce risk of being too close to a specific limit or inflection point (e.g., the weight limit on a bridge). Similar to the concept of redundancy in engineering and quality control, this principle has practical use in many areas of life, such as investment risk management and "rainy day" funds. Key limitations include the time/money trade-off and the frequent reliance on extrapolating from past data.

Simpson's paradox

A change in the association between two variables when the data are separated into groups defined by a third, "lurking" variable (e.g., whether the equipment was damaged).

economic moat

A company's competitive advantage that acts as a virtual barrier for their business over an extended period. Superior companies have deep competitive advantages that are continuously widened. This includes both the strength and sustainability of the advantage, which are needed to help firms fend off competitive destruction. Examples include network effects, intangible assets, cost advantages, switching costs, and efficient scale.

replication

A fundamental building block of diverse biological life is high-fidelity reproduction, based on DNA building blocks.

locus of control

A person's tendency to attribute outcomes either internally to the self or externally to their environment. "Internals" see themselves as shaping their environment (responsibility, agency, self-sufficiency), whereas "externals" view the environment as controlling them.

survivorship bias

A major problem with historiography is that history is famously written by the victors (e.g., we don't hear from the lottery ticket losers). Thus, we over-attribute success to things done by the successful agent rather than to randomness or luck, and we often learn false lessons by exclusively studying victors. In statistics, this can manifest as an error of sampling only a portion of a population that meets some criteria and ignoring the rest, typically due to of a lack of visibility (e.g., GPA doesn't predict success among Google employees, but this only looks at those who were hired).

Baynesian method

A method of thought whereby one takes into account all prior relevant probabilities and then incrementally updates them as newer information arrives. This method is especially productive given the fundamentally non-deterministic world we experience: We must use prior odds and new information in combination to arrive at our best decisions. This is not necessarily our intuitive decision-making engine.

randomized controlled trial (RCT)

A powerful scientific tool to assess causality between variables. The key to ensuring external and internal validity of the experiment is in randomization, both in selecting a sample from the population and in assigning subjects to treatment vs. control. In contrast, observational studies, which seek to understand causal relationships using passively obtained data, can be derailed by confounding if the observed group has distinct characteristics compared to a random sample.

parable of the "sentient puddle"

A puddle wakes up in the morning and finds himself in a hole that fits him "staggeringly well"; the puddle concludes that the world must have been created for him. In reality, the universe was not made for us; instead, we are fine-tuned by evolution to a very narrow range of environmental parameters (i.e., mild changes to our environment will kill us immediately).

first principles thinking

A reasoning tool to help clarify complicated problems by separating the underlying ideas or facts from any assumptions based on them. This type of thinking is one of the best ways to reverse-engineer complicated situations and unleash creative possibility. What remains are the essentials. It's one of the best mental models you can use to improve your thinking because the essentials allow you to see where reasoning by analogy might lead you astray.

Solow growth model

A simplistic yet useful (and surprisingly accurate) framework for explaining long-term potential economic output in terms of capital, labor, savings, investment, and technology. Critically, this "neoclassical" model demonstrates that while increasing savings/investment can raise steady-state output per worker, these improvements are one-offs. Only ongoing increases in technological progress can lead to sustained growth in welfare.

Pareto efficiency

A situation that cannot be modified so as to make any one party better off without making at least one party worse off. Changes that make one party better off without harming any other party are efficient improvements. This concept has been applied to economic efficiency, income distribution, production, engineering, and biology.

sampling error

A statistical mistake that occurs when a sample somehow does not represent the target population. This risk can stem from approaches such as convenience sampling (e.g., people walking into a grocery store) or voluntary response sampling (e.g., voter polls).

sampling bias

A statistical mistake that occurs when the sample isn't randomly chosen, resulting in some members of the intended population having a different sampling probability than others. If this is not accounted for, results can be erroneously attributed to the phenomenon under study rather than to the method of sampling.

"spherical cow" thinking

A systematic model for thinking that demands you be very rigorous, but make conscious, pragmatic trade-offs. Start by isolating a simple part of the problem to get traction, then put this simplified answer back into context and consider whether other factors might be important enough to overturn your conclusion. Remember that, "All models are wrong, some are useful."

Bertrand trap

A type of economic prisoner's dilemma in which two firms compete on prices for an identical good, and the dominant strategy is to undercut prices, with the only stopping point being when all profits are driven away. To avoid this situation, firms should adopt strategies such as differentiating their product, achieving a cost advantage, concealing prices, creating switching costs, limiting quantity, or even colluding.

reinforcement learning

A type of machine learning built on the essential idea that actions that were rewarded would be repeated and those that were punished would not, until the desired behavior is achieved. Applications include ad targeting, recommendation systems, and playing chess.

inverse-reinforcement learning

A type of machine learning relying on the idea that by observing the actions of an intelligent agent that has already learned effective strategies, we can infer the rewards that led to the development of those strategies.

unsupervised learning

A type of machine learning that can detect patterns in data with no labels at all; these algorithms simply look for clusters of features—what scientists call a factor analysis. Potential applications include clustering consumer data (perceptual mapping), fraud detection, and DeepArt.

specialization (pin factory)

Adam Smith's concept about the advantages gained in a free-market system by having workers specialize in one aspect of production rather owning the entire production process. He also cautioned about the trade-off that each worker might not enjoy such a life. Smith provided the famous example of a pin factory he observed in which specialized labor led to a 240x increase in daily output. Also applies to managers delegating work to their employees.

feedback loops

All complex systems are subject to positive and negative response circuits whereby A causes B, which in turn influences A (and C), and so on - with higher-order effects frequently resulting from continual movement of the loop. In a homeostatic system, a change in A is often brought back into line by an opposite change in B to maintain the balance of the system, as with the temperature of the human body or the behavior of an organizational culture.

second-order thinking

Almost everyone can anticipate the immediate results of their actions. This type of first-order thinking is easy and safe but it's also a way to ensure you get the same results that everyone else gets. The next type of thinking is thinking farther ahead and holistically. It requires us to not only consider our actions and their immediate consequences, but the subsequent effects of those actions as well.

meme

An idea that is a replicator (contributes causally to its own copying). Can be rational (relies on recipients' critical faculties to cause itself to be replicated) or anti-rational (relies on disabling the recipients' critical faculties).

inertia

An object in motion with a certain vector wants to continue moving in that direction unless acted upon. This is a fundamental physical principle of motion; however, individuals, systems, and organizations display the same effect. It allows them to minimize the use of energy, but can cause them to be destroyed or eroded.

relativity

An observer cannot truly understand a system of which he himself is a part. For example, a man inside an airplane does not feel like he is experiencing movement, but an outside observer can see that movement is occurring. Applies to physics as well as social systems (e.g., organizations, government).

Pavlovian conditioning

Animals can respond not just to direct incentives but also to associated objects (e.g., dogs salivating at the ring of a bell). Human beings are much the same and can feel positive and negative emotion towards intangible objects, with the emotion coming from past associations rather than direct effects. Can explain phenomena pertaining to human learning and memory (fear, eye-blinking) and emotional conditioning such as phobia, disgust, nausea, anger, and sexual arousal. In an organization, if an employee goes above and beyond and doesn't feel adequately appreciated, he or she may be less likely to work hard the next time.

multiplying by zero

Any number multiplied by zero is zero, no matter how large the number, in mathematical systems as well as human systems. In some systems, a failure in one area can negate great effort in all other areas. As simple multiplication would show, fixing the "zero" often has a much greater effect than does trying to enlarge the other areas.

principle of the golden mean

Aristotle's concept of moderation, in which one should not err toward excess or deficiency, courage or fear. He advocates for moderation, circumspection, measured actions, and judicious compromise. Highly relevant for right-versus-right dilemmas: When your responsibilities or virtues conflict, do not veer too sharply in one direction or another and trample on some fundamental human values as you pursue others.

virtue ethics

Aristotle's theory that ethics is about becoming a person who embodies virtues (e.g., prudence, temperance, courage, justice). Under the "disclosure rule", a person should act in such a way that he or she would be willing to have that behavior broadcast to the public.

first-conclusion bias

As Charlie Munger famously pointed out, the mind works a bit like a sperm and egg: the first idea gets in and then the mind shuts. Like many other tendencies, this is probably an energy-saving device. Our tendency to settle on first impressions leads us to accept many erroneous results and cease asking questions; it can be countered with some simple and useful mental routines.

law of large numbers

As more instances of an event occur, the actual results will converge on the expected ones. Conversely, small samples can and should be looked at with great skepticism. Berkshire Hathaway has long forecasted a decline in future returns based on the company's large size today. As Warren Buffett put it, "Economic progressions, as they grow larger, forge their own mathematical anchors."

commitment & consistency bias

As psychologists have frequently and famously demonstrated, humans are subject to a bias towards keeping their prior commitments and staying consistent with our prior selves when possible. This trait is necessary for social cohesion: people who often change their conclusions and habits are often distrusted. Yet our bias towards staying consistent can become a "hobgoblin of foolish minds"—when it is combined with the first-conclusion bias, we end up landing on poor answers and standing pat in the face of great evidence. The classic antidote is represented by Charles Darwin, who accepted that any scientific theory preferring an alternative explanation to human origins wouldn't be received well, so he spent 20 years cultivating his theory and preparing for its defense.

liking bias

Based on past association, stereotyping, ideology, genetic influence, or direct experience, humans have a tendency to distort their thinking in favor of people or things that they like and against people or things they dislike. This tendency leads to overrating the things we like and underrating or broadly categorizing things we dislike, often missing crucial nuances in the process.

knowledgeable imitation

Behavior that enabled our primitive ancestors to make things like clothes and campfires using knowledge that wasn't in their genes. Such behavior depends on successfully guessing explanations, whether verbal or not, of what other people are trying to achieve and how each of their actions contributes to that.

aggregation theory

Ben Thompson's theory for explaining the success of big internet companies based on those firms having 1) directly relationships with their users, 2) (near) zero marginal costs for serving new users, and 3) demand-driven, multi-sided networks with decreasing acquisition costs (e.g., Facebook, Google, Spotify).

Mr. Market

Benjamin Graham's concept to represent the vicissitudes of the financial markets. As Graham explains, the markets are a bit like a moody neighbor, sometimes waking up happy and sometimes waking up sad—your job as an investor is to take advantage of him in his bad moods and sell to him in his good moods. Contrasted to an efficient-market hypothesis, this implies that the psychological factors of human misjudgment are some of the most important mental models to apply to investment opportunities.

friction and viscosity

Both describe the difficulty of movement, in terms of forces that oppose the movement of objects that are in contact with each other, and in measuring the difficulty how hard it is for one fluid to slide over another. These concepts teach us a lot about how our environment can impede our movement.

ethics of care

Carol Gilligan's theory that ethics isn't just about justice and impartiality, it's also about relationships (e.g., care for the vulnerable, special relationships with family/friends). Unlike other ethical models, her theory is based on the assumptions that people have varying levels of dependence on one another, that others deserve consideration in proportion to their vulnerability, and that contextual factors are critical.

lollapalooza effect

Charlie Munger's term for when several models or tendencies combine to get a "critical mass" of effects or information going in the same direction. We should be very aware of the potential extreme consequences from confluences of psychological tendencies acting in favor of a particular outcome (e.g., the Milgram shock experiments).

multiple mental models

Charlie Munger's analytical approach based on the principle that, just as multiple factors shape almost every system, multiple models from a variety of disciplines, applied with fluency, are needed to understand that system. These models supply the analytical infrastructure needed to reduce complex problems into a clarified set of fundamentals. Often, the forces coming out of these 100 or so models will conflict, and you must make a conscious assessment of the tradeoffs.

problem of points (division of the stakes)

Classical problem that motivated probability theory in the 17th century in which two players agree in advance that the 1st player to have won N rounds (with equal winning probability in each) will collect a prize; if the game is interrupted before either player has won N rounds, how should one divide the prize? Scientists proposed a host of flawed solutions for centuries, until Pascal and Fermat argued that instead of focusing on how the part of the game that had already took place (number of rounds won), we should focus on the game's probabilities, had it continued uninterrupted. This insight was one of the first explicit reasonings about what is today known as expected value.

jobs to be done (JTBD)

Clayton Cristensen's framework for better understanding customer behavior that asserts that people don't simply buy products or services, they "hire" them to make progress in specific circumstances. Instead of focusing on demographic information or product attributes, a business should seek to serve customers based on what they're really hoping to accomplish (i.e., the causal drivers behind a purchase). As Theodore Levitt said, "people do not want a quarter-inch drill, they want a quarter inch hole."

cooperation

Coexists with competition in most biological systems to help groups survive, and results in complex organizational forms.

framing bias

Cognitive bias in psychology resulting from the fact that humans don't naturally make absolute assessments; rather, we rely heavily on points of reference. Thus, the manner in which options are presented can drastically impact our behavior (e.g., positive or negative). Kahneman and Tversky conducted the famous experiment in which 72% of participants chose an option with a positive framing ("saves 200 lives out of 600"), whereas only 22% made the same choice when it was presented with a negative framing ("400 people will die").

illusory superiority

Cognitive bias wherein a person overestimates their own qualities and abilities relative to other people. Usually when we think of our ethical selves, we are thinking of our intentions but not our actions (which aren't always aligned).

price discrimination

Complex form of pricing in which any seller charges a different markup over cost to different buyers (i.e., different prices do NOT reflect cost differences). Such pricing can be more efficient than "simple" pricing by eliminating deadweight loss (value not created) and eliminating consumer surplus (value not captured by the firm).

availability heuristic

Daniel Kahneman's observation that we tend to most easily recall what is salient, important, frequent, and recent. Having a truly comprehensive memory would be debilitating; rather, we rely heavily on that information which can most readily be brought to mind. Some sub-examples include the anchoring, recency, and vividness biases, and the sunk cost fallacy. A potential antidote is the use of checklists to avoid errors and omissions, rather than simply hoping the right information will pop in your head when needed.

System 1 thinking

Daniel Kahneman's term for the human mode of thought that is fast, instinctive, stereotypic, emotional, and unconscious. This type of thinking enables us to do things such as locate the source of a specific sound, solve 2+2=?, complete the phrase "peanut butter and ...", understand simple sentences, etc. Kahneman uses heuristics to assert that such thinking involves associating new information with existing patterns, or thoughts, rather than creating new patterns for each new experience, opening us to a range of potential biases (e.g., anchoring, framing effect).

System 2 thinking

Daniel Kahneman's term for the human mode of thought that is slower, deliberative, logical, infrequent, effortful, and conscious. This type of thinking enables us to do things such as brace for the starter gun in a race, behave appropriately in social settings, park in a tight space, compare washing machines, solve 17x24=?, and assess someone's reasoning. However, it can also cause us to excessively question ourselves and is much too slow and inefficient for making routine decisions.

investigative negotiation

Deepak Malhotra and Max Bazerman's approach to negotiations that involves learning as much as possible about the situation and the people involved, and focusing on each side's underlying interests. Ask why, and seek to reconcile interests (not demands) and create common ground. Listening can create more value than persuading.

bottlenecks and constraints

Describe the place at which a flow (of a tangible or intangible) is stopped, thus constraining it back from continuous movement. These can be small but have a disproportionate impact if it is in the critical path, but can also be a source of inspiration as they force us reconsider if there are alternate pathways to success.

criticality

Describes a system when it is about to jump discretely from one phase to another. The marginal utility of the last unit before the phase change is wildly higher than any unit before it (e.g., water turning from a liquid to a vapor when heated to a specific temperature; or, the mass required to induce a nuclear event). In life, combinations of factors can combine to produce nonlinear results.

ecosystems

Describes any group of organisms coexisting with the natural world. Most show diverse forms of life taking on different approaches to survival, with such pressures leading to varying behavior. Social systems can be seen in the same light as physical ones.

hedonic adaptation

Describes the human tendency to quickly return to a relatively stable level of happiness ("genetic set point") despite major recent positive or negative events or life changes. Confirmed by identical vs. fraternal twin studies, we observe this phenomenon pre-/post-divorce, marriage, children, and widowhood.

moral licensing

Describes the psychological phenomenon that when we believe we are doing something "good" we are more likely to rationalize doing something "bad" towards the same end. Individually, increases in one's self-image or self-concept tends to make that individual less concerned about the consequences of subsequent moral behavior.

pluralistic ignorance

Describes the state in which each person decides that since nobody is concerned, nothing is wrong. Meanwhile, the danger may be mounting to the point where a single individual, uninfluenced by the seeming calm of others, would react.

neural networks

Digital or biological networks that consist of layers of thousands of nodes, each of which is connected to all the nodes in the layers above and below by connections that initially have random strength. The top layer is presented with data, and the bottom layer is given the correct answer. Any series of connections that happened to land on the right answer is made stronger ("rewarded"), and those that were wrong are made weaker ("punished"). Repetition is "training".

opportunity cost

Doing one thing means not being able to do another. We live in a world of trade-offs ("there is no such thing as a free lunch").

Baumol's cost disease

Economic idea that for sectors with modest or low technological innovation, an increase in the cost of an input will translate into an increase in production costs over time, driving up prices. The U.S. is observing this phenomenon in education and healthcare, where productivity is stagnant but prices are increasing sharply.

marginal thinking

Economic principle that requires decision-makers to evaluate the benefits and costs of one additional unit or one fewer unit or some resource (e.g., one more slice of pizza, one more hour of activity). When assessing something like future costs or revenue, decision makers should be wary of using "averages", since rates of change in a variable may depend on the quantity of that variable.

comparative advantage

Economist David Ricardo's unusual and non-intuitive insight that two individuals, firms, or countries could benefit from trading with one another even if one of them was better at everything. Best seen as an applied opportunity cost: If it has the opportunity to trade, an entity gives up free gains in productivity by not focusing on what it does best.

creative destruction (competitive destruction)

Economist Joseph Schumpeter's term describing the capitalist process at work in a functioning free-market system. Motivated by personal incentives (including but not limited to financial profit), entrepreneurs will push to best one another in a never-ending game of innovative one-upmanship, in the process destroying old ideas and replacing them with newer technology. Few businesses survive over multiple generations; beware getting left behind.

catalyst

Either kick-starts or maintains a chemical reaction, but isn't itself a reactant. The reaction may slow or stop without it. Social systems take on many similar traits.

probabilistic thinking

Essentially trying to estimate, using some tools of math and logic, the likelihood of any specific outcome coming to pass. It is one of the best tools we have to improve the accuracy of our decisions. In a world where each moment is determined by an infinitely complex set of factors, it helps us identify the most likely outcomes.

churn

Every year, a certain number of customers are lost and must be replaced. Standing still is the equivalent of losing, as seen in the model called the "Red Queen Effect." This is present in many business and human systems: A constant figure is periodically lost and must be replaced before any new figures are added over the top.

arbitrage

Exists if a certain good can profitably be bought in one market and sold at a profit in another market without risk. These opportunities will nearly always eventually disappear as they are discovered and exploited.

rational choice theory

Framework for understanding social and economic behavior based on the premise that individuals have a complete, consistent set preferences among the available choices, and they select the best possible option taking account of available information, probabilities, costs and benefits. This individual behavior is widely used as an assumption in microeconomic models, political science, sociology, and philosophy. However, experimental results from behavioral economics and psychology challenge this theory and often better predict human decision-making.

man-with-a-hammer tendency

From the proverb, "To a man with a hammer, every problem tends to look pretty much like a nail." Charlie Munger frequently used this tendency to argue that professionals need more multidisciplinarity skill, since they tend to be trained in one model (e.g., economics) and try to solve all problems in one way.

trust

Fundamentally, the modern world operates on trust. Familial trust is generally a given (otherwise we'd have a hell of a time surviving), but we also choose to trust chefs, clerks, drivers, factory workers, executives, and many others. A trusting system is one that tends to work most efficiently; the rewards of trust are extremely high.

tit-for-tat

Game theoretic strategy based on the key insight was that when a game is repeated many times, players can sustain cooperation (sometimes!) by adopting strategies that reward cooperation and punish defections. This can make cooperation rational, even in a game that is a prisoner's dilemma in each step (e.g., the "tournament of robots").

scarcity

Game theory describes situations of conflict, limited resources, and competition. Given a certain situation and a limited amount of resources and time, what decisions are competitors likely to make, and which should they make? One important note is that traditional game theory may describe humans as more rational than they really are.

algorithms

Generally, an automated set of rules or a "blueprint" leading a series of steps or actions resulting in a desired outcome, and often stated in the form of a series of "If → Then" statements. Best known for their use in modern computing, but are a feature of biological life as well (e.g., human DNA).

Popper's criterion

Good political institutions are those that make it as easy as possible to detect either a ruler or policy is a mistake, and to remove rulers or policies without violence when they are.

banality of evil

Hannah Arendt's concept of how evil often comes from a trite, mundane lack of careful reasoning by otherwise decent people. When ethical crises occur, we usually look for a villain behind the scandal. Although villains clearly exist, when you look behind most ethical failures, you will find a lot of well-meaning people who reasoned carelessly or incompletely. As Hannah Arendt said, "The sad truth of the matter is that most evil is done by people who never made up their mind to be either bad or good."

emergence

Higher-level behavior tends to result from the interaction of lower-order components. The result is frequently not linear - not a matter of simple addition - but rather non-linear, or exponential (e.g., hurricanes, sand dunes, social networks). Importantly, tautologically this behavior cannot be predicted from simply studying the component parts.

social proof (safety in numbers)

Human beings are one of many social species, along with bees, ants, and chimps, among many more. We have a DNA-level instinct to seek safety in numbers and we're all influenced—subconsciously and, to some extent, consciously—by what we see others do, not do, and approve. This instinct creates a cohesive sense of cooperation and culture which would not otherwise be possible but also leads us to do foolish things if our group is doing them as well. Especially acute in the presence of puzzlement or stress.

narrative instinct

Human beings have been appropriately called "the storytelling animal" because of our instinct to construct and seek meaning in stories. It's likely that long before we developed the ability to write or to create objects, we were telling and thinking in stories. Applies to nearly all social organizations (e.g., religious institutions, corporations, nation-states).

extrinsic incentives bias

Human tendency to assume that everyone else is more motivated by extrinsic incentives (e.g., money, status) than intrinsic incentives (e.g., learning a new skill), and that others are more extrinsically motivated than ourselves.

tendency to feel envy and jealousy

Humans have a tendency to covet when others receive more than they are, and a desire "get what is theirs" in due course. The pull towards envy is strong enough to drive otherwise irrational behavior, but is as old as humanity itself. Any system ignorant of envy effects will tend to self-immolate over time.

reciprocity

If I push on a wall, physics tells me that the wall pushes back with equivalent force. In a biological system, if one individual acts on another, the action will tend to be reciprocated in kind. Also observed in human behavior, with the behavioral rule that we should try to repay, in kind, what another person has provided us. Such behavior creates a "web of indebtedness" that allows us to divide labor, exchange goods/services, and create interdependencies that bind us together in efficient units. However, this obligation can be used against us to influence our behavior, and it can backfire when others don't behave as we expect (e.g., warfare).

fine-tuning

If the laws of physics were slightly different, there would be no life.

deontology

Immanuel Kant's theory that ethics is about universal principles (absolute rules), discoverable through reason, rather than about consequences. Kant demanded that people strictly do their moral duty, and his "categorical imperative" stipulated that you should act only in ways such that you would want that behavior to become universal law. According to Kant, your "means" must be morally right, and cannot be justified by the "ends".

regression to the mean

In a normally distributed system, long deviations from the average will tend to return to that average with an increasing number of observations (i.e., the Law of Large Numbers). We are often fooled by this (e.g., sports streaks, herbal remedies), so we must be careful not to confuse statistically likely events with causal ones.

tendency to minimize energy output (mental & physical)

In a physical world governed by thermodynamics and competition for limited energy and resources, any biological organism that was wasteful with energy would be at a severe disadvantage for survival. Thus, we see in most instances that behavior is governed by a tendency to minimize energy usage when at all possible.

seizing the middle

In chess, the winning strategy is usually to seize control of the middle of the board, so as to maximize the potential moves that can be made and control the movement of the maximal number of pieces. The same strategy works profitably in business, as can be demonstrated by John D. Rockefeller's control of the refinery business in the early days of the oil trade and Microsoft's control of the operating system in the early days of the software trade.

sensitivity to fairness

In line with Immanuel Kant's famous "categorical imperative", justice runs deep in our veins. In another illustration of our relative sense of well-being, we are careful arbiters of what is fair. Violations of fairness can be considered grounds for reciprocal action, or at least distrust. Yet fairness itself seems to be a moving target over time (e.g., slavery has been seen as perfectly acceptable in alternating phases of history).

irreducibility

In most systems there are quantitative properties (e.g., complexity, minimums, time, and length) such that below a certain level the desired result simply does not occur. One cannot get several women pregnant to reduce the amount of time needed to have one child, and one cannot reduce a successfully built automobile to a single part.

utilitarianism

John Stuart Mill's theory that ethics is about ensuring the best outcomes for the greatest number of people. In other words, follow the "Greatest Happiness" principle, or the idea that the goal of society should be to bring about the greatest happiness for the greatest number of people. This approach forces us to think long-term about the outcomes of our decisions; however, it is intellectually taxing, often involves substantial uncertainty, and can be employed liberally as a rationalization.

echo chambers

Like-minded people tend to only listen to each other, resulting in extreme polarization on what should more-or-less be objective facts.

virtu

Machiavelli's word for the moral code of public life: A combination of pride, bravery, skill, forcefulness, and an amount of ruthlessness coupled with the willingness to do evil when necessary. Machiavelli believed that weak leaders/organizations accomplish little in the world because they are preoccupied with survival, that fortune favors the bold, and that one must sometimes be a "fox to recognize traps" (more often) and sometimes be a "lion to frighten wolves."

AD-AS model

Macroeconomic model that helps us understand how short-run fluctuations lead to changes in the business cycle (i.e., deviations from the Solow model's steady-state output). Business cycles occur because aggregate demand and aggregate supply change at different times. If there were perfect information about prices and all prices changed immediately, there would be no business cycles or unemployment, but many prices are sticky in the short-run (especially wages), leading firms to adjust production based on the prices they see.

STP (segmentation, targeting, and positioning)

Marketing process that involves differentiating groups of customers based on their benefits sought (JTBD), targeting the most attractive segments based on potential profitability and competitive differentiation, and identifying a unique selling proposition for your product such that it will occupy a clear, distinctive, and attractive position relative to competing products in consumers' minds. This analysis should serve as a prerequisite for marketing strategy.

modern portfolio theory (MPT)

Mathematical framework for assembling a portfolio of assets such that the expected return is maximized for a given level of risk (i.e., variance). It is a formulation and extension of diversification in investing, with the key insight that an asset's risk and return should not be assessed by itself, but rather by how it contributes to a portfolio's overall risk and return. Despite its theoretical importance, critics assert that the risk, return, and correlation metrics used are based on expected values, which cannot capture the true statistical features of highly-skewed (e.g., log-normal) distributions.

random walk

Mathematical term for a stochastic or random process, a path that consists of a succession of random steps on some mathematical space. An elementary example involves a number line with an integer starting at 0 that moves +1 or -1 with equal probability. This process explains the observed behaviors in many fields, including physics (the path traced by a molecule as it travels in a liquid or gas), biology (the path of a foraging animal), financial economics (the path of a fluctuating stock price), and psychology (memory, decision making).

asymmetric warfare

Military model whereby one side seemingly "plays by different rules" than the other side due to circumstance. Generally, this model is applied by an insurgency with limited resources. Unable to out-muscle their opponents, asymmetric fighters use other tactics, as with terrorism creating fear that's disproportionate to their actual destructive ability.

sunk cost fallacy

Mistake that often involves taking future action to rationalize past choices. To avoid these fallacies, take the view of an outsider, who's not bound by any past actions. According to traditional microeconomic theory, only prospective (future) costs and rewards are relevant to a rational decision.

parochialism

Mistaking appearance for reality, or local regularities for universal laws. It's easy to mistake quirks of one's own, familiar environment or perspective (such as the rotation of the night sky) for objective features of what one is observing, or to mistake rules of thumb (such as the prediction of daily sunrises) for universal laws.

CAPM (capital asset pricing model)

Model in modern portfolio theory which derives the theoretical required expected return (i.e., discount rate) for an asset in a market, given the risk-free rate available to investors and the asset's sensitivity to non-diversifiable (market) risk. Once you derive an asset's expected future return, you can establish the "intrinsic" price for the asset as the present value of its future cash flows. While useful for its simplicity and applicability, the model does not appear to adequately explain the variation in stock returns or anomalies such as size and value effects. It assumes that investors are rational and risk-averse, relies on extrapolating past data to represent future risk/returns, and it assumes that risk measures (e.g., variance) are constant over time.

decision funnel (AIDA)

Model proposing that marketing messages need to accomplish a number of tasks in order to move the consumer through a series of sequential steps from brand awareness through to action (awareness, interest, desire, action).

bureaucracy

Modern organizational structure typically involving four things: 1) hierarchy (clearly defined spheres of competence and divisions of labor), 2) continuity (salaried administrators who advance within the structure), 3) impersonality (prescribed rules and operating rules rather than arbitrary actions), and 4) expertise (officials are chosen according to merit, have been trained, and hold access to knowledge). Charlie Munger argues that a side effect is that businesses tend to "balkanize reality into little individual departments with territoriality and turf protection and so forth", slowing decision making and making it advantageous to have a mind that can jump the jurisdictional boundaries.

hierarchical organization

Most complex biological organisms have an innate feel for how they should organize, especially in the animal kingdom. There's a great human bias towards being influenced by authority (e.g., Milgram Experiments, Stanford Prison Experiment). In a dominance hierarchy such as ours, we tend to look to the leader for guidance on behavior, especially in situations of stress or uncertainty. Thus, authority figures have a responsibility to act well, whether they like it or not.

law of diminishing returns

Most important real-world results are subject to an eventual decrease of incremental value.

niches

Most organisms find a method of competing and behaving for survival. Usually, a species will select a specialty for which it is best adapted. The danger arises when multiple species begin competing for the same one, which can cause an extinction - there can be only so many species doing the same thing before limited resources give out.

relative satisfaction/misery tendencies

Nearly all studies of human happiness show that it is related to the state of the person relative to either their past or their peers, not absolute. These relative tendencies cause us great misery or happiness in a very wide variety of objectively different situations and make us poor predictors of our own behavior and feelings.

checklist routines

Objectivity tools that help prevent a lot of errors and omissions (e.g., the long list of prerequisite checks that pilots must do before flight). Charlie Munger advocates these as one of the most important thinking tactics to ensure you objectively apply multidisciplinary tools. "You've got to use those tools checklist-style because you'll miss a lot if you just hope that the right tool is going to pop up unaided whenever you need it."

bribery

Often ignored in mainstream economics, the concept that, given the chance, it is often easier in human systems to pay a certain agent to look the other way than to follow the rules. The enforcer of the rules is then neutralized. This principle/agent problem can be seen as a form of arbitrage.

hindsight bias

Once we know the outcome, it's nearly impossible to turn back the clock mentally. Our narrative instinct leads us to reason that we knew it all along (whatever "it" is), when in fact we are often simply reasoning post-hoc with information not available to us before the event. This bias explains why it's wise to keep a journal of important decisions for an unaltered record and to re-examine our beliefs when we convince ourselves that we knew it all along.

double-entry bookkeeping

One of the marvels of modern capitalism has been the accounting system introduced in Genoa in the 14th century. The system requires that every entry, such as income, also be entered into another corresponding account. Correct bookkeeping acts as a check on potential accounting errors and allows for accurate records and thus, more accurate behavior by the owner of a firm.

decision tree analysis

One of the most useful tools in decision making involving graphical representations of a decision problem as a series of decision nodes and branching alternatives, leading to eventual payoffs or consequences. This approach is especially useful for situations with sequential decisions, decision making under uncertainty (by applying probability theory), and modeling strategic interactions (game theory).

seeing the front

One of the most valuable military tactics—before making decisions, not always relying on advisors, maps, and reports, all of which can be either faulty or biased. The Map/Territory model illustrates the problem with not seeing the "front", as does the incentive model. Leaders of any organization can generally benefit from seeing the front, as not only does it provide firsthand information, but it also tends to improve the quality of secondhand information.

motivated beliefs

Our beliefs about ourselves are shaped in part by our emotional needs (e.g., self-esteem, reassurance about the future, justification for past actions). We feel terrible when we disappoint ourselves. Thus, our beliefs and supposed deep preferences are highly context-dependent, and thus shouldn't be taken too literally. We don't like to change our minds because we don't like to admit we were wrong to begin with; instead, we look for evidence that we are right.

reason-respecting tendency

People simply like to have reasons for what they do. We learn better and are more compliant when we are provided a reason, even if the reason is meaningless or incorrect.

supervised learning

Perhaps the simplest type of machine learning that involves the use of a labeled training data set to predict or classify an outcome or variable of interest. Applications include churn prediction, image recognition, and voice-to-text.

stoicism

Philosophical school whose principal aim was to provide meaning and direction for everyday life, generally comprised of three disciplines: 1) Perception (absolute objectivity of thought), 2) Unselfishness (existence for others), and 3) Will (focus only on things within our control). Famously championed in Marcus Aurelius' "Meditations".

leverage points

Places within complex systems (a corporation, an economy, a living body, a city, an ecosystem) where a small amount of input force can produce a great output force. Understanding where we can apply this model to the human world can be a source of great success. Begin by identifying the greatest areas for improvements right now, and even in complex systems, small shifts can create big, permanent changes.

inversion

Powerful thinking tool that involves approaching a situation from the opposite end of the natural starting point. By helping you identify and remove obstacles to success, you can often and easily solve problems that would otherwise resist solution, given the way adaptive systems and mental constructs work. Relies on the fundamental principles of algebra (e.g., a=b and b=c, so it must be true that a=c). Mathematician Carl Jacobi often solved problems with his strategy, "Invert, always invert." Famously, instead of lecturing students on how to live a good life, Johnny Carson in a commencement speech provided his "prescription for misery", which included ingesting chemicals to alter mood or perception, envy, and resentment. Charlie Munger adds to this list unreliability, not learning from others' mistakes, and "go down and stay down".

second-degree price discrimination (menu pricing)

Pricing strategy in which customers self-select among slightly different products with varying prices. Menu options can vary in quality (versioning), composition (bundling), or quantity (quantity discounts). Companies may even "hobble" one version of the product in order to charge more for another version (e.g., basic economy on airlines).

third-degree price discrimination (segment pricing)

Pricing strategy whereby businesses discriminate customers into different segments based on some observable characteristic(s) (e.g., student/senior discounts). Relies on the assumption that different groups segregated by these characteristics have different willingness to pay.

LASSO ("Least Absolute Shrinkage and Selection Operator")

Probably the best known machine learning algorithm, it takes a standard multiple regression model and imposes an additional constraint that the slopes should not be too large. This "penalty" helps avoid spurious correlation by emphasizing only a few highly-predictive explanatory variables. Often when you use this method, you get most explanatory variables with zero slope, and a few with statistically significant slopes.

focus investing

Process that approaches investing in equities from the perspective of a business owner, maintaining a concentrated portfolio of businesses that the investor believes has a high probability of outperforming the market over an extended period of time. In direct contrast to the "modern portfolio theory" concept of diversification, this approach has been used by Berkshire Hathaway based on the principle that good investments are very hard to find, so you shouldn't make very many of them. As Charlie Munger asked a group of USC students, "How many of you have fifty-six brilliant insights in which you have equal confidence? Raise your hands, please. How many of you have two or three insights that you have some confidence in? I rest my case."

economic value to the customer (EVC)

Product pricing model that involves analyzing 1) the alternatives against which customers will assess your product (reference value), and 2) the incremental value you create for your customers (differentiation value). However, be extremely considerate of psychological factors that could affect (lower) customers' perceived value if they don't understand the value they get or why/how prices are set or changed.

scale

Properties (or behaviors) of systems tend to change when you scale them up or down. In studying complex systems, we must always be roughly quantifying—in orders of magnitude, at least—the scale at which we are observing, analyzing, or predicting the system. Clear applications in business include that as companies process more volume in their operations, they get better at processing that problem.

Bloom's 2 sigma problem

Refers to an educational phenomenon reported in 1984 that the average student tutored one-to-one using mastery learning techniques performed two standard deviations better than students who learn via conventional instructional methods (i.e., the average tutored student outperformed over 98% of the control-group students). One implication is that labeling students as low achievers is less relevant, since altering one or two variables can have significant positive effects on the average learner.

Occam's Razor

Simpler explanations are more likely to be true than complicated ones. Instead of wasting your time trying to disprove complex scenarios, you can make decisions more confidently by basing them on the explanation that has the fewest moving parts.

preferential attachment (cumulative advantage)

Situation that occurs when the current leader is given more of the reward than the laggards, thereby tending to preserve or enhance the status of the leader. A strong network effect is a good example.

mutually assured destruction (MAD)

Somewhat paradoxically, the stronger two opponents become, the less likely they may be to destroy one another, though any destruction may be more severe. Occurs not just in warfare, as with the development of global nuclear warheads, but also in business, as with the avoidance of destructive price wars between competitors.

natural selection and extinction (part of evolution)

Species evolve through random mutation and differential survival rates. If we call human intervention in animal-breeding an example of "artificial selection," we can call Mother Nature deciding the success or failure of a particular mutation "natural selection." Those best suited for survival tend to be preserved. But of course, conditions change.

adaptation (part of evolution)

Species tend to adapt to their surroundings in order to survive, given the combination of their genetics and their environment - an always-unavoidable combination. However, adaptations made in an individual's lifetime are not passed down genetically, as was once thought: Populations of species adapt through the process of evolution by natural selection, as the most-fit examples of the species replicate at an above-average rate.

velocity

Speed plus vector: how fast something gets somewhere. Much more useful than speed, which ignores the vector/direction.

normal distribution

Statistical process that leads to the well-known graphical representation of a bell curve, with a meaningful central "average" and increasingly rare standard deviations from that average when correctly sampled. (The so-called "central limit" theorem.) Well-known examples include human height and weight, but it's just as important to note that many common processes, especially in non-tangible systems like social systems, do not follow such a distribution.

language instinct

Steven Pinker's term for humans' DNA-level instinct (not simply a cultural artifact) to learn grammatically constructed language. We use these instincts to create shared stories, as well as to gossip, solve problems, and fight, among other things.

influence of stress (including breaking points)

Stress causes both mental and physiological responses and tends to amplify the other biases. Almost all human mental biases become worse in the face of stress as the body goes into a fight-or-flight response, relying purely on instinct without the emergency brake of Daniel Kahneman's "System 2" type of reasoning. Stress causes hasty decisions, immediacy, and a fallback to habit, thus giving rise to the elite soldiers' motto: "In the thick of battle, you will not rise to the level of your expectations, but fall to the level of your training."

intellectual property rights (e.g., trademarks, patents, and copyrights)

Suite of legal frameworks that protect the creative work produced by enterprising individuals, thus creating additional incentives for creativity and promoting the creative-destruction model of capitalism. Without these protections, information and creative workers have no defense against their work being freely distributed.

backup systems

Systems will not have perfect reliability, thus the engineer must build in redundancy to protect the integrity of the total system. Without the application of this robustness principle, tangible and intangible systems tend to fail over time.

central limit theorem

Tells us that the distribution of a sample mean is approximately normal, regardless of the distribution for underlying observations. Incredibly powerful in statistics, this enables us to conduct a lot of different tests, such as computing margin of error and target sample size, building control limits for production processes, assigning confidence intervals, and making a conscious trade-off on false positive and false negative rates.

representativeness heuristic

Term for a category of biases coined by Kahneman and Tversky comprised of 1) Failure to Account for Base Rates (unconscious failure to look at past odds), 2) Tendency to Stereotype (tendency to broadly generalize and categorize rather than look for specific nuance), and 3) Failure to See False Conjunctions (tendency to view vivid examples as more representative than vaguer descriptions).

BATNA (best alternative to a negotiated agreement)

Term for the course of action that a person will take if a negotiation ends in an impasse. Determining this is the first step in preparing for a negotiation. Three steps: 1) Identify all plausible no-deal alternatives, 2) Estimate the value of each, and 3) Select the best alternative.

reservation value

Term for your walk-away point in a negotiation (i.e., your indifference point between doing the deal or not). The difference between each side's point represents the zone of possible agreement (ZOPA).

two-front war

The Second World War was a good example of a two-front war. Once Russia and Germany became enemies, Germany was forced to split its troops and send them to separate fronts, weakening their impact on either front. In practical life, opening a two-front war can often be a useful tactic, as can solving a two-front war or avoiding one, as in the example of an organization tamping down internal discord to focus on its competitors.

Parkinson's law

The adage that "work expands so as to fill the time available for its completion". To avoid procrastination and gravitating towards low-hanging fruit, break down projects into sub-tasks small enough that they are no longer intimidating or stress-inducing. Use time-boxing to put yourself on a clock. This principle has also been formed as a mathematical equation describing the rate at which bureaucracies expand over time, irrespective of the amount of work being completed.

surface area

The amount of space on the outside of a three dimensional object. Could be preferable to be larger (e.g., our lungs to increase oxygen and nutrient absorption), or smaller (e.g., internet attack surfaces).

supply and demand

The basic equation of biological and economic life is one of limited supply of necessary goods and competition for those goods. Just as biological entities compete for limited usable energy, so too do economic entities compete for limited customer wealth and limited demand for their products. Equilibrium points exist, but tend to be dynamic and changing, never static.

incentives

The basic instinct of creatures to respond to stimuli to keep themselves alive. Humans are complicated in that their motivations can be hidden or intangible. The rule of life is to repeat what works and has been rewarded. These should be designed with great care. For example, does Safelite Autoglass paying their repair workers based on time spent encourage sloth? Does paying them based on the number of repair jobs completed encourage skimping on quality? In establishing laws and regulations, lawmakers must consider second- and third-order effects in incentivizing lying and cheating.

the neurological habit loop ("CCRR")

The constant human cycle of receiving and responding to stimuli, looking for rewards and dopamine (Clue → Craving → Response → Reward). Humans are constantly being driven by this cycle, but they can consciously affect it.

curiosity instinct

The distinctly human instinct to learn a great deal about the world around us, using that information to create the world in our collective minds. Leads to unique human behavior and forms of organization like the scientific enterprise. Humans innovated even before there were direct incentives to do so.

Yerkes-Dodson law

The empirical psychological relationship between arousal and performance, which dictates that performance increases with physiological or mental arousal, but only up to a point (i.e., a bell-shaped curve). At too-low or too-high levels of arousal, performance decreases.

the Red Queen effect (part of evolution)

The evolution-by-natural-selection model leads to something of an arms race among species competing for limited resources. When one species evolves an advantageous adaptation, a competing species must respond in kind or fail as a species. Standing still can mean falling behind.

bounded rationality

The idea that rationality in individual decision-making is limited by the tractability of the decision problem, the cognitive limitations of the mind, and the time available to make the decisions. Decision-makers, then, act as "satisficers", using heuristics and seeking a satisfactory solution rather than an optimal one.

Spaceship Earth

The idea that, "The biosphere is a life-support system for humans." Outside the biosphere, the universe is implacably hostile, but the interior is a vastly complex life-support system. David Deutsch believes this metaphor is mistaken: the Earth is particularly inhospitable to life. 99.9% of all species that have ever existed are extinct. Almost the entire capacity of the Earth's life-support system has been provided not for humans but by humans, using our ability to create knowledge.

principle of mediocrity

The idea that, "There is nothing special about humans [in the cosmic scheme of things]," and that humans are biologically limited in their ability to understand the universe. Stephen Hawking said humans are "just a chemical scum on the surface of a typical planet that's in orbit round a typical star on the outskirts of a typical galaxy." Even the "special" values we apply to ourselves are inherently anthropocentric. David Deutsch argues this idea is mistaken: humans are capable of creating knowledge, and once they have suitable knowledge they are capable of sparking unlimited progress.

activation energy

The input of a critical level of this energy is necessary in order to get a reaction started; two combustible elements alone are not enough.

algebraic equivalence

The introduction of algebra allowed us to demonstrate mathematically and abstractly that two seemingly different things could be the same. By manipulating symbols, we can demonstrate equivalence or inequivalence, the use of which led humanity to untold engineering and technical abilities.

global and local maxima

The largest value over a mathematical function's domain, and smaller peaks of value in a given range. Help us identify peaks, and if there is still potential to go higher or lower. Reminds us that sometimes we have to go down to go back up.

thermodynamics

The laws cannot be escaped and underlie the physical world. They describe a world in which useful energy is constantly being lost, and energy cannot be created or destroyed. Applying their lessons to the social world can be a profitable enterprise.

efficiency wage

The logic that the wage a firm must pay to get its workers to work typically has to be high enough that being fired actually hurts. Remember the old Soviet joke: "They pretend to pay us, we pretend to work."

the map is not the territory

The map of reality is not reality. Even the best maps are imperfect. That's because they are reductions of what they represent. If a map were to represent the territory with perfect fidelity, it would no longer be a reduction and thus would no longer be useful to us. A map can also be a snapshot of a point in time, representing something that no longer exists.

Type II error (false negative)

The mistake of failing to take action (failing to reject a false null hypothesis) when action is needed (e.g., not firing Jimmy if he's stealing). For example, in the context of binary classification, when trying to decide whether an input image X is an image of a dog: an error of omission is classifying X as not a dog when it is. Reducing this type of error (omission) directly increases the opposite type of error (commission). However, since mistakes of omission aren't visible, they tend to receive much less attention.

Type I error (false positive)

The mistake of taking action (rejecting a true null hypothesis) when no action is needed (e.g., firing Jimmy when he's not stealing). For example, in the context of binary classification, when trying to decide whether an input image X is an image of a dog: an error of commission is classifying X as a dog when it isn't. Reducing this type of error (commission) directly increases the opposite type of error (omission).

entropy

The natural state of all systems is to flow to lower energy states (i.e., the tendency of things to go from ordered to disordered states). All things will fall apart eventually, including the universe itself, and including our sun in around five billion years. As Neil DeGrasse Tyson quipped, "You don't want to be around for that; you want to be planet-hopping your way to safety long before this happens."

advantages of scale

The nature of organizational activity that as you do operate with larger volume, you get better at processing that volume. These benefits can manifest in production efficiency advantages, marketing and advertising economies, and purchasing power. However, there are also disadvantages, such as the emergence of inefficient bureaucracies as organizations grow.

confirmation bias

The often unconscious bias that "what we wish, we also believe" and "what we believe is what we choose to see". It is a deeply ingrained mental habit, both energy-conserving and comfortable, to look for confirmations of long-held wisdom rather than violations. This behavior is often unintentional and results from ignoring inconsistent information. Yet the scientific process - including hypothesis generation, blind testing when needed, and objective statistical rigor - is designed to root out precisely the opposite, which is why it works so well when followed.

customer lifetime value (CLV)

The present value of the expected future income stream generated by an individual purchaser, net of customer acquisition costs. In business, this analysis is extremely useful in understanding the potential value of customers, assessing how much you should pay to acquire them, gaining insight into groups of consumers, and devising bespoke strategies for different types of customers and different stages of the relationship (e.g., by rewarding, "firing", or cross-selling customers). Such strategies can create substantial value: A 2004 study found that a 1% improvement in customer retention rate was associated with a nearly 5% increase in firm value.

first-degree price discrimination (individual pricing)

The pricing strategy of of charging each customer a different amount based on their willingness to pay. This can include personalized coupons, auctions, or personal sales (e.g., car dealers). Also known as perfect price discrimination, this strategy, while rare in reality, enables the firm to capture all available consumer surplus for itself.

multiple comparisons problem

The problem inherent in a data analysis that with a large enough number of comparisons there is an increasing risk of false positive findings (spurious correlations), which typically vastly outnumber genuine insights.

value-alignment problem

The problem with AI stemming from the fact that humans define the robot's reward function, which is meant to incentivize robot behavior that matches what the end user wants. However, intuitive reward functions, when combined with unusual instances of a task, can lead to unintuitive behavior (e.g., a vacuum robot spitting out more dust just so it can suck it back in again and get more reward).

coordination problem

The problem with AI that optimizing the robot's reward function in isolation is different from optimizing it when the robot acts around people, because people take actions, too.

compounding

The process by which we add interest to a fixed sum, which then earns interest on the previous sum and the newly added interest, and so on ad infinitum. It is an exponential effect, rather than a linear, or additive, effect (e.g., money, ideas, relationships). In tangible realms, this phenomenon is always subject to physical limits and diminishing returns; intangibles can compound more freely.

homeostasis and equilibrium

The process through which systems self-regulate to maintain an equilibrium state that enables them to function in a changing environment. Most of the time, they over or undershoot it by a little and must keep adjusting.

ZOPA (Zone of Possible Agreement)

The set of all possible deals that would be acceptable to both parties in a negotiation. Equal to the difference between each side's reservation values (walk-away points).

regression models

The statistical building blocks for machine learning. They come in different forms (e.g., linear, curved), but with the shared goal of describing an underlying relationship between two variables in order to predict the future. For instance, log models are useful in economics, where concepts like diminishing returns exist, the effect of the predictor variable often depends on its size, and we often think in terms of % changes rather than changes in the level of a variable (e.g., prices and quantity, income, profits and productivity).

statistical significance

The statistical condition that exists when the probability that the observed findings are due to chance is very low, at a certain level of confidence (e.g., 95%).

self-preservation

The strong instinct in an organism's DNA that helps prevent it from disappearing over time. While cooperation is another important model, this instinct is strong in all organisms and can cause violent, erratic, and/or destructive behavior for those around them.

loss aversion

The strong tendency to regard losses as considerably more important than gains of comparable magnitude—and, with this, a tendency to take steps (including risky steps) to avoid possible loss. Moreover, if something we earned or received is stripped away, we can react strongly. We see this phenomenon in diverse fields, such as gambling, investing (not selling poor-performing stocks), labor relations (it's very hard to reduce wages), and bureaucratic organizations (infighting over the threatened loss of territory).

Fraud Triangle

The three factors that contribute to unethical or illegal behavior: opportunity, pressure, and rationalization.

customer acquisition cost

The total spending required to generate one new customer (e.g., the cost of sending an instrument used to generate a response). For this investment to be worthwhile, the lifetime revenue generated from each user must be greater than upfront this cost.

utility (marginal, diminishing, increasing)

The usefulness of additional units of any good tends to vary with scale. Marginal utility allows us to understand the value of one additional unit, and in most practical areas of life, that utility diminishes at some point. On the other hand, in some cases, additional units are subject to a "critical point" where the utility function jumps discretely up or down. As an example, giving water to a thirsty man has diminishing marginal utility with each additional unit, and can eventually kill him with enough units.

hormesis

There can be favorable effects of low exposure to physical, chemical, or biological agents or processes that have adverse effects at higher exposure levels (e.g., alcohol, saunas, exercise, fasting).

social contract theory

Thomas Hobbes' theory that ethics is about filling your obligations to society (societal norms, obligations to shareholders, etc.). Social cooperation enables us to do vastly more than we could individually, but this requires certain behaviors (e.g., telling the truth, keeping our promises, respecting others' lives and property). This theory has the benefit of practicality, but it offers a pessimistic view of people/society (as not innately altruistic) and allows no mechanism for social change. If we strictly abide by existing social norms, how do we get rid of bad beliefs or regimes?

counterinsurgency

Though asymmetric insurgent warfare can be extremely effective, over time competitors have also developed defense strategies. Recently and famously, General David Petraeus led the development of plans that involved no additional force but substantial additional gains. Tit-for-tat warfare or competition will often lead to a feedback loop that demands insurgency and counterinsurgency.

randomness

Though the human brain has trouble comprehending it, much of the world is composed of arbitrary, non-sequential, non-ordered events. We are "fooled" by unsystematic effects when we attribute causality to things that are actually outside of our control. Leads to false confidence that things are more predictable than they really are.

A/B testing

Type of experiment in which subjects are randomly assigned to either a control or treatment group, the treatment group is then exposed to some change (e.g., new feature, design, or algorithm), and key metrics are computed and compared to determine whether the treatment had some causal impact on the subjects (e.g., whether exposure to a digital ad resulted in a purchase). These tests are particularly useful for internet companies, as their large digital user bases enable fast experimentation, iteration, and improvement. Critically, causality is only inferable if users are randomly assigned to control versus treatment groups. If the assignment is not truly random (i.e., correlates to some pre-existing characteristic), then experiments may simply show correlation or reverse causation.e

sampling variation

Variation of a statistic from one sample to the next caused by selecting random subsets of the population. A major task in statistics is to describe the distribution of X̄ (the expected mean of a randomly chosen sample with mean x) without knowing the properties of the underlying population.

tendency to want to do something (fight/flight, intervention, demonstration of value, etc.)

We might term this Boredom Syndrome: Most humans have the tendency to need to act, even when their actions are not needed. We also tend to offer solutions even when we do not have knowledge to solve the problem.

Hanlon's Razor

We should not attribute to malice that which is more easily explained by inability or neglect. In a complex world, using this model helps us avoid paranoia and ideology. By not generally assuming that bad results are the fault of a bad actor, we look for options instead of missing opportunities. This model reminds us that people do make mistakes. It demands that we ask if there is another reasonable explanation for the events that have occurred. The explanation most likely to be right is the one that contains the least amount of intent.

fundamental attribution error (tendency to overestimate consistency of behavior)

We tend to over-ascribe the behavior of others to their innate traits rather than to situational factors, leading us to overestimate how consistent that behavior will be in the future. In such a situation, predicting behavior seems not very difficult. Of course, in practice this assumption is consistently demonstrated to be wrong, and we are consequently surprised when others do not act in accordance with the "innate" traits we've endowed them with.

overconfidence bias

Well-established bias in which man mostly misappraises himself on the high side. Manifests in humans overestimating their performance, placement relative to others, and accuracy in their beliefs. A well-known study found that 90% of Swedish drivers thought they were above-average. Leads to other troublesome results such as the endowment effect (belief that one's possessions are more worth more than one would otherwise pay for them) and similarity bias (preference for people like ourselves).

circle of competence

When ego and not competence drives what we undertake, we have blind spots. If you know what you understand, you know where you have an edge over others. When you are honest about where your knowledge is lacking, you know where you are vulnerable and where you can improve. Similar to Charlie Munger's investment approach, which is to make relatively few bets, and only on "simple, understandable candidates." When a professor in the audience asked a difficult question to physicist Max Planck's chauffeur, who had given a recitation of Planck's repetitive speech, the chauffeur said, "Well, I'm surprised that in an advanced city like Munich I get such an elementary question. I'm going to ask my chauffeur [Planck] to reply."

incentive-caused bias

When our complex incentives cause us to distort our thinking when it is in our own interest to do so. A wonderful example is a salesman truly believing that his product will improve the lives of its users. It's not merely convenient that he sells the product; the fact of his selling the product causes a very real bias in his own thinking. Driven both consciously and unconsciously by incentives, humans can drift into immoral behavior in order to get what they want, rationalizing the results (natural consequence: agency cost).

denial

When the reality is too painful to bear, one distorts the facts until they become bearable. Denying reality can be a coping mechanism, a survival mechanism, or a purposeful tactic. Usually mixed up with love, death, and chemical dependency, where denial has powerful destructive effects but allows for behavioral inertia. In chemical dependency, addicted persons tend to believe that they remain in respectable condition with respectable prospects. Notably, Alcoholics Anonymous routinely achieves a 50% cure rate by causing several psychological tendencies to act together to counter addiction.

alloying

When we combine various elements, we create new substances. A byproduct can be far stronger than the simple addition of the underlying elements would lead us to believe. This process leads us to engineer great physical objects, but we understand many intangibles in the same way.

tendency to overgeneralize from small samples

With generalizing comes a subset of errors when we forget about the Law of Large Numbers and act as if it does not exist. We take a small number of instances and create a general category, even if we have no statistically sound basis for the conclusion.