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December 31, 2019 - May 22, 2020
When these conditions are met, entities surrounding the externality will transact among themselves until th...
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cap-and-trade systems, which are modern-day applications of the Coase theorem.
The government also sets a fixed number of total permits, which serves as the emission cap in the market, similar to the imposed limit on the number of cows that could graze on Boston Common. Then companies can trade permits on an open exchange. Such a system satisfies the conditions of the Coase theorem because property rights are well defined through the permitting process, companies act rationally to maximize their profits, and the open market provides low transaction costs.
If you’re in charge of any system or policy, you want to think through the possible negative externalities ahead of time and devise ways to avoid them.
What spillover effects could occur, and who would be ...
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This phenomenon, known as moral hazard, is where you take on more risk, or hazard, once you have information that encourages you to believe you are more protected. It has been a concern of the insurance industry since
Agency can lead to other issues as well, collectively known as the principal-agent problem, where the self-interest of the agent may lead to suboptimal results for the principal across a wide variety of circumstances.
Moral hazard and principal-agent problems can occur because of asymmetric information, where one side of a transaction has different information than the other side; that is, the available information is not symmetrically distributed.
When parties select transactions that they think will benefit them,
based at least partially on their own private information, that’s called adverse selection.
rampant and persistent asymmetric information in a market can lead to its collapse. Consider a used car market where the sellers know
Goodhart’s law summarizes the issue: When a measure becomes a target, it ceases to be a good measure.
suppose you ask your employee to achieve an insurance target, he may sell insurance product by providing wrong information or cheating customer and achieve a target, his target was achieved but his means was wrong which dilutes the effectiveness of target.
“The more any quantitative social indicator is used for social decision-making, the more subject it will be to corruption pressures and the more apt it will be to distort and corrupt the social processes it is intended to monitor.
When you try to incentivize behavior by setting a measurable target, people focus primarily on achieving that measure, often in ways you didn’t intend.
is a mental model for this more specific situation, called the cobra effect, describing when an attempted solution actually makes the problem worse.
cobra effect, describing when an attempted solution actually makes the problem worse.
This model gets its name from a situation involving actual cobras. When the British were governing India, they were concerned about the number of these deadly snakes, and so they started offering a monetary reward for every snake brought to them. Initially the policy worked well, and the cobra population decreased. But soon, local entrepreneurs started breeding cobras just to collect the bounties. After the...
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increasing the cobra population e...
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Whenever you create an incentive structure, you must heed Goodhart’s law and watch out for perverse incentives, lest you be overrun by cobras and rats!
The Streisand effect applies to an even more specific situation: when you unintentionally draw more attention to something when you try to hide
A related model to watch out for is the hydra effect, named after the Lernaean Hydra, a beast from Greek mythology that grows two heads for each one that is cut off.
hydra effect,
Don’t kick a hornet’s nest, meaning don’t disturb something that is going to create a lot more trouble than it is worth.
Goodhart’s law, along with the cobra, hydra, and Streisand effects
if you are going to think about changing a system or situation, you must account for and quickly react to the clever ways people may respond.
observer effect, where there is an effect on something depending on how you observe it, or even who observes it.
The observer effect is certainly something to be aware of when making actual measurements, but you should also consider how people might indirectly change their behavior as they become less anonymous.
Weinberg, Gabriel; McCann, Lauren. Super Thinking (p. 52). Penguin Books Ltd. Kindle Edition.
. The implication is that when people realized they were being watched by their governments, some of them stopped reading articles that they thought could get them into trouble. The name for this concept is chilling effect.
chilling effect.
The observer effect is certainly something to be aware of when making actual measurements, but you should also consider how people might indirectly change their behavior as they become less anonymous.
Weinberg, Gabriel; McCann, Lauren. Super Thinking (p. 52). Penguin Books Ltd. Kindle Edition.
More generally, chilling effects are a type of observer effect where the threat of retaliation creates a change in behavior.
Again, it is best to think ahead about what behaviors you are actually incentivizing by your action, how there might be perverse incentives at play, and what collateral damage or even blowback these perverse incentives might cause.
tyranny of small decisions, where a series of isolated and seemingly good decisions can nevertheless add up to a bad outcome.
good short-term decisions that can still add up to a bad outcome in the long term. The mental model often used to describe this class of unintended consequences is called the boiling frog:
the one who doesnt make gradual changes in day to day lifes are first to succumb in long term.
privacy. It is sometimes paired with another animal metaphor, also scientifically untrue—that of the ostrich with its head in the sand, ignoring the signs of danger. In each case the unintended consequence of not acting earlier is eventually an extremely unpleasant state that is hard to get out of—global warming, domestic violence, mass surveillance.
In each case the unintended consequence of not acting earlier is eventually an extremely unpleasant state that is hard to get out of—global warming, domestic violence, mass
path dependence, meaning that the set of decisions, or paths, available to you now is dependent on your past decisions.
set of decisions, or paths, available to you now is dependent on your past decisions.
For any decision, ask yourself: What kind of debt am I incurring by doing this? What future paths am I taking away by my actions today?
dependence: preserving optionality. The idea is to make choices that preserve future options.
The idea is to make choices that preserve future options.
The downside of keeping many options open is that it often requires more resources, increasing costs.
the precautionary principle: when an action could possibly create harm of an unknown magnitude, you should proceed with extreme caution before enacting the policy. It’s like the medical principle of “First, do no harm.”
On an individual level, the precautionary principle instructs you to take pause when an action could possibly cause you significant personal harm.
too much information leads to information overload, which complicates a decision-making process. The excess information can overload the processing capacity of the system,
analysis paralysis, where your decision making suffers from paralysis because you are over-analyzing the large amount of information available.
by not making a choice, you are actually making a choice: you are choosing the status quo, which could be considerably worse than one of the other choices you could already have made.
Some decisions are consequential and irreversible or nearly irreversible—one-way doors—and these decisions must be made methodically, carefully, slowly, with great deliberation and consultation.
you’ve made a suboptimal [reversible] decision, you don’t have to live with the consequences for that long. You can reopen the door and go back through …. As organizations get
Another way to help combat analysis paralysis is to limit choice, because the more choices you have, the harder it is to choose between them.
They found that a greater number of choices increased the decision time logarithmically, in a formulation now known as Hick’s law
Hick’s law to remember that decision time is going to increase with the number of choices, and so if you want people to make quick decisions, reduce the number of choices.
wealth of options can create anxiety in certain contexts.
