Mental Models

Latticework of Mental Models: The Power Law

Do you know how much property damage and loss of lives is caused by earthquakes every year?

No idea? Consider this – An earthquake in Japan in 2011 caused an estimated property loss of US$ 235 billion. The deadliest earthquake in recorded history (in terms of loss of lives) occurred in Shaanxi (China) killing more than 800,000 people.

According to one study, annual average losses from earthquakes range from US$ 1.3 to 5.7 billion. That’s loss per year because of all the earthquakes. This is quite huge, considering that it’s caused by an event which we have no control over.

These statistics show that when mother nature’s fury is unleashed, even the modern society with all its technology and resources, finds itself helpless.

Now another question. What do you think is the average loss caused by an earthquake, in terms of dollars per earthquake? Let’s do a quick back of the envelope calculation. So yearly loss of US$ 5.7 billion divided by number of earthquakes per year. How much would that be? Take a guess.

Probably that number would be couple of million dollars per earthquake. Right?

It’s actually little over US$ 10,000. That’s it! How come?

Latticework of Mental Models: Framing Effect

“Is it okay to smoke a cigarette while praying to God?” a young man asked his father, a religious man.

“Of course it’s bad. It’s a great sin and very disrespectful act,” the father replied. He was disturbed with his son’s atrocious question.

“But last time you told me that to get rid of my addiction I should start praying while smoking. Didn’t you say that?” It seemed to him that his father was contradicting himself.

“No my son! Don’t confuse smoking-while-praying with praying-while-smoking,” the father explained.

“But what’s the difference?” the son was perplexed.

“There is a difference. A huge difference. I don’t know what but my brain tells me that there is.”

Now before we get started on a debate about the validity of father’s argument, let me clarify that the reason I brought up this anecdote was to highlight an important mental bias which plays out in our affairs very subtly.

Why Good People Do Bad Things: A Conversation With My Daughter

Volkswagen, the world’s third largest in terms of vehicle sales, recently admitted to cheating on emissions data for 11 million of its diesel engine cars sold between 2009 and 2015.

As I was explaining the scandal to my daughter, the first question she asked was – “Why do they do such wrong things, Papa? Aren’t they already rich?”

“Good question Kavya,” I said. “It’s especially good to know that you understand what they did i.e., cheat their customers, was wrong.”

“But they are good people, right Papa?” she asked.

“Yes the people who created the scandal must have come from good families,” I replied, “…and must have been good with their family and friends.”

“So why good people do bad things?” she asked again, this time combining all her questions into one.

“Let me tell you a story, Kavya,” I said, “…story of a young girl named Barbie.”

“Wow, Barbie is my favorite doll,” she exclaimed with a smile.

“Yeah, but for the time being, let’s forget that she is a doll and let’s focus on the story.”

Latticework of Mental Models: Pavlovian Conditioning

Last month I decided to pay a visit to my friend Dr. Placebo in his clinic. It was a Friday and for some strange reason people are too happy to fall sick on a Friday. So it was a relatively less busy day for my doctor friend. For that matter it should be easy for you to guess the busiest day of the week for him – Monday of course. 🙂

I wasn’t sick as such but I like to catch up with Dr. Placebo once in awhile. In the past he has helped me in thinking about important mental models including Do Something Bias [1] and Mean Reversion [2]. So I was hoping that a chit chat with him will again nudge me to some fresh insights. I wasn’t wrong.

“So doc! Tell me something ironical about your profession?”, I asked him thinking that a question like that could lead the conversation to an interesting direction.

“The biggest irony of being a physician is that many people don’t really need doctor’s help. Many a times, my prescription is effective because people believe in them. Their belief in my treatment is what cures them. You see your doctor and you feel better.”

He continued, “Sometimes just the fact that a doctor or nurse is paying attention to us and reassuring us not only makes us feel better but also triggers our internal healing processes. In many cases they would benefit just by popping a sugar pill. And it’s a proven fact also known as Placebo Effect.”

“I see. That kind of explains your strange name.”, I winked thinking that he wouldn’t mind a friendly tease.

“Don’t get me started on the origins of my name. But you should read about Pavlovian Conditioning. Now if you please excuse me, I have to leave now. It’s Friday and I have plans.”, saying this he got up from his chair and started leaving.

Latticework of Mental Models: Inversion

Watch this one minute video [1] and when you’re done smiling, think about the problem in a rational way.

At first, the problem seemed that the kid had his head stuck between the iron bars. Although nobody saw how the kid’s head really got trapped in the first place – they just assumed that he somehow managed to slide his head through the narrow bars. Naturally, the intuitive solution was to pull the head in the same way it got stuck – which obviously didn’t seem to work.

But the right solution appeared when people stood the problem on its head (no pun intended) i.e., instead of trying to pull the head they pushed in the body through the trap. They inverted the problem and voila! Problem solved.

That’s called principle of inversion. It’s a common trick used by mathematicians but rarely practiced outside the discipline of mathematics. Carl Jacobi, a German mathematician, said, “Invert, always invert”, expressing his belief that the solution of many hard problems can be clarified by re-expressing them in inverse form.

Latticework of Mental Models: Moral Hazard

Millions of years ago, before the agriculture revolution, when homo sapiens was still living life as a hunter-gatherer, there was this one naturally occurring phenomenon which aroused a sense of wonder, fear and longing at the same time in his mind. The phenomenon occurred on its own in nature and humans found it very useful but it espoused extreme dread too because of its destructive capabilities.

I think you can guess what I am talking about. That natural phenomenon was fire!

About 100,000 years ago, humans finally learned how to create fire and it accelerated the development of human race. Fast forward to this day. Even after having developed technologies to create, douse and control all sorts of fires, wildfire is one thing where humans have found themselves helpless in front of mother nature.

Wildfire kills 339,000 people every year[1], even today! So why we haven’t been able to do much about wildfire carnages? Agreed, we can’t prevent a tsunami or an earthquake but we can surely prevent and contain a fire. Right?

The surprising truth is that with the help of modern technology the number of wildfires have come down drastically over the last hundred years but the total destruction caused by these fires hasn’t gone down proportionately. It even seems to have increased.

Latticework of Mental Models: Feedback Loops

Few weeks back, Vishal was conducting the Art of Investing workshop in Bangalore and he asked me to speak on the subject of human behaviour and how it relates to investing.

Now, unlike him, I am not used to speaking in front of a large audience. Although it was a room full of around 50 people, but for me anything more than two is a crowd. So to say that I had butterflies in my stomach would be an understatement. It felt like flying horses in my belly.

Finally when Vishal handed over the mic to me, one part of my brain was trying hard to control my shaking legs, the other part was busy adjusting (with trembling hands) the microphone attached to my shirt.

Just when the first word came out from my mouth, a loud screeching noise echoed in the room. For a moment I thought that my heart, which by that time was pounding hard against my chest, had come out. Then I realized that the loud noise was coming from the speakers. I immediately cut it by covering the mic with my hand.

It’s a pretty common problem (sound from the speakers feeding back into the microphone, and then going in an unending loop between speaker and mic, often causing a loud squeal) and most of you must be familiar with this kind of audio feedback noise. This acoustic problem can be easily corrected by tuning the instruments and using few filters. But what’s fascinating about this feedback loop phenomenon is that it pervades almost every other natural as well as man-made systems.

So let’s explore this mental model i.e., Feedback Loop, and see how it can help us understand the world around us.

Latticework of Mental Models: Do Something Bias

Note: This article first appeared in the March 2015 issue of our premium newsletter, Value Investing Almanack.

Do you remember Dr. Placebo and Mr. Irrational?

They teamed up for our discussion on Mean Reversion, but kind of disappeared after that.

Although Mr. Irrational did come back for Contrast Mis-Reaction but Dr. Placebo, who runs a thriving practice, has been finding it hard to take out time from his busy schedule. So this time I made him an irresistible offer. Vishal and I offered him a discount on Value Investing Almanack subscription, which he just couldn’t refuse.

As far as Mr. Irrational is concerned, he’s my buddy, almost like my alter ego. So he has to come when I ask.

Let’s enter Dr. Placebo’s clinic. He has this very interesting quote, uttered by famous scientist Blaise Pascal, displayed in the patient waiting area –

All of humanity’s problems stem from man’s inability to sit quietly in a room alone.

He hopes that his waiting patients learn something from this deep thought, but little does he realize that more than his patients, he is the one who needs to meditate over Pascal’s quote.

Latticework of Mental Models: Tragedy Of Commons

I have never been bitten by a dog (by an unfriendly dog to be precise). However, there were few friendly ones who would chase me for fun. Well it was fun for them but as a kid I didn’t particularly enjoy that kind of sport much.

So when I moved into my current apartment community, housing nearly two thousand flats, it felt nostalgic because the campus had multiple patches of large open areas which meant it was a boon for dog owners (and heaven for their dogs).

Few years back, it wasn’t uncommon to see few fitness conscious dogs taking regular morning and evening walks (along with their disinterested owners) inside the apartment campus. But as the resident population grew, the population of pets followed suit. Pretty soon, it became a common practice for dogs to relieve themselves anywhere in the campus.

The pet owners perhaps assumed that cleaning was a responsibility of maintenance staff which resulted in a campus littered with dog poop everywhere. It was ironical that the mess was equally disturbing for all residents (including those offending dog owners) but it was quite logical, in absence of any specific laws about pet poop mis-management, for people to keep their houses clean and compromise with the common area.

I couldn’t help but marvel at Aristotle’s insight about this issue. He said –

What is common to many is taken least care of, for all men have greater regard for what is their own than for what they possess in common with others.

Latticework of Mental Models: Thermodynamics

The big idea that we are going to look at today is from the field of Physics and it’s called Thermodynamics. Before you get too scared of the big word let me assure you that we’re not going to be discussing any mind bending formulae here.

In fact, here a confession is in order.

The subject of Thermodynamics has fascinated me since my college days. And the fascination was mostly because it provoked more dread than excitement. Perhaps my bad karma from past life, call it Karma-dynamics, made sure that I barely got passing marks in any paper related to Thermodynamics.

So trust me, I won’t even make an attempt to go anywhere near complex equations.

The plan is to learn some basics and use that knowledge to gain useful insights that will help us make an educated guess about few interesting problems. What kind of problems? Here is one for starter –