Tag: taleb

Diamonds, (and Guns and Gulaabs)

“Even economics is based on the notion of “revealed preferences.” What people “think” is not relevant—you want to avoid entering the mushy-soft and self-looping discipline of psychology. People’s “explanations” for what they do are just words, stories they tell themselves, not the business of proper science. What they do, on the other hand, is tangible and measurable and that’s what we should focus on. This axiom, perhaps even principle, is very powerful but is not followed too much by researchers. Revelation of preferences is best understood by the betrothed: a diamond, particularly when it is onerous to the buyer, is vastly more convincing a commitment (and much less reversible) than a verbal promise.”

Skin in the Game, (A Brief Tour of Symmetry, Prologue, Part 2) by Nicholas Nassim Taleb

Before we move on to today’s topic, here’s some advice for you if you are just beginning your study of economics. Read as many books as you can lay your hands on by Taleb, and ask yourself why he disses economics so. You don’t have to agree with him – that is up to you – but you should try and understand where he’s coming from.

But now on to today’s topic.

Say you’ve finished learning a bit about economics, and you think you’re beginning to “get it”. Incentives matter, trade matters, prices matter yada-yada-yada. We get it. Demand curves slope downwards, and actually, if you think about it, economics is simple.

Yes?

Well, then answer me this: if the price of diamonds goes down, will demand for engagement rings increase, or decrease?

Take your time, there’s no hurry.

As I’m fond of saying in my classes, “whatever your answer, please also tell me why it is whatever it is”.

So – if you’ve learnt well, you should have predicted that demand will go up. The lower the price, the higher the demand will be!

Except, as it turns out, the world ain’t quite so simple. In the case of engagement rings, a reduction in the price of diamonds will lower the demand for ’em.

Why?

Because as both Imperial Blue and Taleb tell us, “a diamond, particularly when it is onerous to the buyer, is vastly more convincing a commitment (and much less reversible) than a verbal promise.”

That is, the point of buying the ring is to show to your betrothed that you have skin in the game. If it is cheap, it don’t count. How do you show your commitment to the relationship? By putting down an eye-wateringly large amount of money to buy a ring. If the eyes don’t water, it don’t count.

You will learn about value-in-use and value-in-exchange sooner or later as a student of economics. Turns out there is also value in signaling. And the value in signaling comes from how expensive the good is, in the case of the diamond ring.

De Beers started selling its own lab-grown diamonds in 2018 at a steep discount to the going price, in an attempt to differentiate between the two categories. The company expects lab-grown prices to continue to tumble, in what it sees as a tsunami of more supply coming on to the market, Rowley said. That should create an even bigger delta in prices between natural diamonds and lab grown, helping differentiate the two products, he said.

https://marginalrevolution.com/marginalrevolution/2023/09/a-diamond-pricing-puzzle.html

Please read the whole post, as always. But if lab-grown diamonds are indistinguishable from, well, natural diamonds, they ought to be substitutes. And if they are substitutes, a reduction in the price of one good ought to lead to a reduction in the price of its substitute. If Coca-Cola is made cheaper, Pepsi has very little choice but to follow.

Then how do we explain a company like De Beers deliberately reducing the price of a substitute? Not just reducing it! They’re saying that the reduction in the price is what helps differentiate the products!

This is a nuanced point, and worth a deeper explanation.

De Beers accepts and acknowledges that lab grown diamonds are substitutes for natural diamonds. It accepts that there is bound to be a reduction in the price of lab-grown diamonds because of the “tsunami” of the increase in supply of lab-grown diamonds.

So how do they try and ensure that the demand for natural diamonds stays the same? By reducing the price of lab-grown diamonds even more than the market price. Demand for natural diamond goes up, the cheaper the lab grown diamonds are. De Beers is simply hastening that process.

As I’m fond of saying, you should always ask a simple question: what are you optimizing for?

And in the case of diamond rings, you ain’t optimizing for saving money. You’re optimizing, in fact, for spending money.

Signaling matters!

And speaking of skin in the game, if you can’t afford a diamond ring, what might make for an acceptable substitute…?

Play Like an Athlete?

Tyler Cowen has an excellent blogpost which should be read by everybody, titled “Learn like an athlete, knowledge workers should train“:

“Recently, one of my favorite questions to bug people with has been “What is it you do to train that is comparable to a pianist practicing scales?” If you don’t know the answer to that one, maybe you are doing something wrong or not doing enough. Or maybe you are (optimally?) not very ambitious?

https://marginalrevolution.com/marginalrevolution/2019/07/learn-like-an-athlete-knowledge-workers-should-train.html

He followed up on that post a few days later with some examples of how he trains on a daily basis. That post is difficult to excerpt from, and so I won’t, but I urge you to read the entire thing. As an aside, I think the most underrated word in his post is “partial“. So very tantalizing, no?

I teach economics for a living, so I am very much a knowledge worker. What do I do to train like an athlete?

  1. As with Tyler, I teach, and the returns from engaging with students have been, are and very likely will continue to be stratospheric. Educational institutes seem to go out of their way to make this the least important activity for knowledge workers, more’s the pity. In my opinion, teaching is the single most important thing that a knowledge worker can do. And that applies to students as well! Teach. Write blogs, create videos, record podcasts, argue with your batchmates, argue with your professors – all of these are forms of teaching, and you can never do too much teaching.
  2. I try and write everyday, here on EFE. Over the past two years or so, there have been extended periods of time where I haven’t felt like writing, and I haven’t beaten myself up over it. If you don’t feel like it, you shouldn’t do it. (On a somewhat tangential note, read this. I have found it to be useful advice.)

But, I am sorry to report, I do not read anywhere near as much as I should, and this sorry trend has only exacerbated during the pandemic. Podcast listening is very much a thing I like to do when I drive, so that has also taken a hit during the pandemic. And I would like to figure out how to create videos as a way to teach at scale, but I just find writing to be easier, faster and something I’m better at right now. So if at all I train like an athlete, it is at a very mediocre level, at best.

But what am I training for?

To be a better athlete knowledge worker, sure, but to what end? Athletes train like athletes in order to win matches or competitions. Knowledge workers should train like athletes to win too, but the knowledge worker sport is a very different one, because knowledge workers play non-zero sum games.

Athletes win by defeating other athletes. That’s the nature of sport. Although athletes, when they’re not actually engaged in competition with each other, seem to be very willing to share tips and tricks, and the best ones go out of their way to mentor their fellow athletes. RIP, Shane Warne!

Knowledge workers win by helping others (not just knowledge workers!) win. Well, they should, at any rate.

Hold on to that thought for a second…

This sentence stood out for me in a recent Sidharth Monga piece:

So here we had a strange instance of the side ahead in the game playing lower percentages and the side needing to make all the play sticking with percentages.

https://www.espncricinfo.com/story/ipl-2022-rr-vs-kkr-how-kolkata-knight-riders-fumbled-against-the-genius-of-yuzvendra-chahal-1311429

And here’s what I’ve been playing around with – if us knowledge workers are training like athletes, it is for a game called life. As I explained above, I train like a mediocre athlete at best. How then should I play the percentages in a non-zero sum game?

Here are my current answers:

  1. If the winning strategy is to help myself by helping others as much as possible, I should, at the margin, read more, write more and teach more. Anything that distracts me from this should be avoided or discarded. That’s the (counter-intuitive) low-risk percentage play, assuming I’m correct about the winning strategy.
  2. But there is (always) a non-zero possibility that this may not be the winning strategy, so I should try and help myself a little bit for my own sake. And this in fact gives me the freedom to double down on pt. 1 regardless!
  3. I really should be training harder, dammit. This is self-evident, but also a little nuanced. I should be training harder in any case, because it is A Good Thing, but also to prepare myself for any opportunity that may come up to help others. Teaching economics to non-economists, teaching statistics to lawyers, teaching econometrics to grad students in econ, teaching people how to use technology to make themselves more productive, teaching project management to students so that they can become more productive – all are examples of teaching and all are non-zero sum games. And I should be doing more besides. And more urgently than I am right now.

Train like an athlete, and be as clear as possible about the answer to that irritating question that just won’t go away: what are you optimizing for?

But I suppose trying to answer that eternal question is itself a form of training, so there’s that. No?

A thought provoking Twitter thread from Anup Malani

I usually keep interesting Twitter threads for Saturdays, but this one is deserving of additional commentary and additional reading links:

Unintended consequences, or externalities, or spillovers (some might say these aren’t really interchangeable terms) are a well studied phenomenon in economics, as Anup Malani himself says. Read the classic paper, and listen to many, many conversations over on EconTalk about the topic to get a better understanding.

Anup Malani says towards the end of that first tweet that he has seen economics give explanations for 1 (but not for 2, which we’ll get to later). So what are the explanations for 1? For us to understand the explanations, let us first take a look at the examples that Anup Malani cites in this thread:

And as he himself says in a subsequent tweet in this thread, these phenomena can be understood using simple price theory. Driving becomes safer as a consequence of the introduction of seat belt laws. What does one do with this increased safety? One can either benefit from it by maintaining the same driving speed as before, or one can “spend” the increased benefit by increasing the driving speed.

If, for example, you are the kind of person who thought you were a safe and competent driver before wearing seat belts, you might now think that wearing the seat belt makes you safer still. But you were ok with the level of safety you had before – you are now “extra” safe. But that’s “too” safe for you, so you up the speed at which you drive. Students who have studied basic micro before, kudos if you were reminded of this. If you haven’t formally studied micro before, please do watch that video.

So, price theory helps us “get” how to think about unintended consequences. Although this does raise the rather interesting question about whether one should have anticipated these effects in advance (us economists, we don’t like using simple words. We say ex-ante instead of in advance. It’s the same thing.)

And if we could have anticipated these effects in advance, then were they really unintended consequences in the first place? Something to think about, eh? Maybe that’s why these terms (externalities, unintended consequences and spillovers) aren’t really interchangeable?

But now we get to the second case. Part two of Anup Malani ‘s first tweet in this thread: that which does not kill you makes you stronger.

What are examples of this phrase? (Here’s the Wikipedia article about the phrase itself)

Vaccines, of course! They make you sick sometimes (you are, after all, injecting yourself with a dramatically weakened version of the virus), but they leave you stronger in the sense that you body “learns” how to cope with the virus if it actually does enter you body. Vaccines don’t kill you, and they make you stronger!

But that’s an example from the field of biology. What about economic systems?

Anup Malani gives excellent three excellent examples in his thread, I’ll just mention one over here. Please take a look at the other two as well.

Import of cloth from India, where wages were low, threatened the domestic British cloth-making industry. It didn’t kill this industry, but it did threaten it. And the British responded by increasing mechanization. And the rest is, well, literally history.

Now, this is where Anup Malani ‘s Twitter thread really takes off for me. Price theory, he says, helps us understand unintended consequences. What theory helps us understand “that which does not kill you makes you stronger”?

Anup Malani says we don’t really know.

Might Nassim Nicholas Taleb’s book, Anti-Fragile, have an answer?

Antifragility is a property of systems in which they increase in capability to thrive as a result of stressors, shocks, volatility, noise, mistakes, faults, attacks, or failures. The concept was developed by Nassim Nicholas Taleb in his book, Antifragile, and in technical papers.

https://en.wikipedia.org/wiki/Antifragility

I’m not sure, and I might be wrong about this, but I think the answer is yes, it does have an answer. Read, in the context of what we’re speaking about in this blog post, chapter 4 from this book very carefully. Here’s one excerpt from that chapter to help you get started:

Nietzsche’s famous expression “what does not kill me makes me stronger” can be easily misinterpreted as meaning Mithridatization or hormesis. It may be one of these two phenomena, very possible, but it could as well mean “what did not kill me did not make me stronger, but spared me because I am stronger than others; but it killed others and the average population is now stronger because the weak are gone.” In other words, I passed an exit exam. I’ve discussed the problem in earlier writings of the false illusion of causality, with a newspaper article saying that the new mafia members, former Soviet exiles, had been “hardened by a visit to the Gulag” (the Soviet concentration camps). Since the sojourn in the Gulag killed the weakest, one had the illusion of strengthening. Sometimes we see people having survived trials and imagine, given that the surviving population is sturdier than the original one, that these trials are good for them. In other words, the trial can just be a ruthless exam that kills those who fail. All we may be witnessing is that transfer of fragility (rather, antifragility) from the individual to the system that I discussed earlier. Let me present it in a different way. The surviving cohort, clearly, is stronger than the initial one—but not quite the individuals, since the weaker ones died. Someone paid a price for the system to improve.

Taleb, Nassim Nicholas. Antifragile (p. 76). Penguin Books Ltd. Kindle Edition.

Mithridization? Here you go. Hormesis? Click here.

This blog post isn’t the place to get into the details of chapter four from Anti-Fragile. Please, do read the entire chapter (and the entire book!)

It is, of course, all too possible that I’m entirely wrong in saying that this is a good answer to Anup Malani’s question. And if you think so, I would love to learn how I’m wrong.

But for the moment, this is my first pass answer to a fascinating question at the end of a lovely thread.

Five Articles/Posts for the 3rd of July, 2020

  1. “Accordingly, antifragile systems and organisms tend towards a common theme: bottoms-up decision-making, rather than top-down decision making. Antifragility requires real options, and real options are low-cost. Antifragility is only successful if you can actually detect, react, and grow in response to deviations from your present state in real time; the only way you can feasibly do this is for disorder detection and response to take place at a small enough resolution, and tight enough turnaround time. Top-down systems have a hard time with antifragility, because for them, all options are costly.”
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    I’m late in posting this, having read this a while ago, but a useful essay by Alex Danco on how to think about anti-fragility, the term coined and popularized by Taleb. There are a lot of very useful ways to think about anti-fragility, but this essay explores immunity and how to think about our bodies immunity from the prism of anti-fragility. I found it especially useful to think about our bodies (which are at risk from the virus) and our governments (which are supposed to help us protect ourselves against the virus) and ask which is more anti-fragile, and why.
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  2. Kevin Kelly (a man worth learning more about) recently posted “68 bits of unsolicited advice“. Each advice is worth reading – here’s one that is easy to understand, difficult to implement on a sustained basis. Ask me. I should know.
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    “Being enthusiastic is worth 25 IQ points.”
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  3. “Grades destroy curiosity. Too many kids learn for the sole purpose of raising their GPA because that’s what the system incentivizes. From an early age, I observed that my success in school depended more on my grades and less on how much I learned. In college, even though I wrote essays on my own and worked as an intern in New York City for companies like Skift, I was almost kicked out of my fraternity because my GPA was below 3.0. Likewise, my college counselors evaluated me on two metrics: grades and SAT scores. Neil deGrasse Tyson once said: “When students cheat on exams, it’s because our school system values grades more than students value learning.””
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    Read this essay by David Perell. Please. Read it.
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  4. This link came to me via Recommendo, which is a newsletter I have subscribed to about a month or so ago. Worth a ponder, it is about the art of critical thinking.
  5. Great visualizations, as always, from the NYT. This one is about the spread of the coronavirus in the USA.

Ec101: Links for 9th January, 2020

Five articles on sunk costs today.

  1. First up, a somewhat basic introductory article. Feel free to skip it if you’re sure you know what sunk costs are (pausing only to note that it is not so much the knowing that matters with sunk costs, but remembering to apply it)
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  2. “The United States has invested much in attempting to achieve its objectives. In addition to the many millions of dollars that have been spent, many thousands of lives have been lost, and an even greater number of lives have been irreparably damaged. If the United States withdraws from Vietnam without achieving its objectives, then all of these undeniably significant sacrifices would be wasted”
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    The quote itself is a quote (if you see what I mean) from this paper, which is a wonderful rumination on sunk costs. Read Taleb on the subject (and not just his tweets!)
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  3. This entire post by Alex Tabarrok is very short (and I have linked to it before, I think), but it is worth reading. Especially the last sentence: do think about it, if you are an economics student.
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  4. “Once your model of choice is at all complex, no one knows what a sunk cost means any more. So a theoretical scolding of those who honor “sunk costs” is not completely well-defined. That being said, there is still the empirical question of whether most people attach too much weight to previous plans and have a status quo bias. The experimental evidence suggests that we are more rigid than we need to be. The propensity to honor previous commitments may have efficiency properties, but we cannot discard this proclivity when we ought to.”
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    The bottom line from Tyler Cowen’s post on the topic. He was responding to Tabarrok’s post above.
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  5. “Suppose that you are trying to pursue a morally worthy goal, but cannot do so without incurring some moral costs. At the outset, you believed that achieving your goal was worth no more than a given moral cost. And suppose that, time having passed, you have wrought only harm and injustice, without advancing your cause. You can now reflect on whether to continue. Your goal is within reach. What’s more, you believe you can achieve it by incurring—from this point forward—no more cost than it warranted at the outset. If you now succeed, the total cost will exceed the upper bound marked at the beginning. But the additional cost from this point is below that upper bound. And the good you will achieve is undiminished. How do the moral costs you have already inflicted bear upon your decision now?”
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    I am reminded, very strongly indeed, of the Mahabharata. That is the abstract of this paper.

EC101: Links for 11th July, 2019

  1. “The two approaches reflect different attitudes toward risk, the role of government and collective social responsibility. Analogous to America’s debate over health insurance, the American philosophy has been to make more resilient buildings an individual choice, not a government mandate.”
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    Risk, how (not) to measure it and therefore understand it. As Taleb is fond of saying, “The absence of evidence is not the evidence of absence”.
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  2. “Is it possible that interest rates are a net input cost in the Indian context? This existential monetary question is yet to be even acknowledged by economists, let alone addressed.”
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    A superb (and I use the word advisedly) overview of monetary policy and how it works in India.
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  3. “I would challenge my students at the start of the new semester with the following three questions; 1) how much does it cost you to go to the beach (we lived in a coastal city)? 2) should Tiger Woods mow his own lawn? or 3) should Lebron and Kobie go to college?”
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    Opportunity costs, economic costs and accounting costs – all in one article, and therefore a great read.
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  4. “The cornerstone of Harvard professor N. Gregory Mankiw’s introductory economics textbook, Principles of Economics, is a synthesis of economic thought into Ten Principles of Economics (listed in the first table below). A quick perusal of these will likely affirm the reader’s suspicions that synthesizing economic thought into Ten Principles is no easy task, and may even lead the reader to suspect that the subtlety and concision required are not to be found in the pen of N. Gregory Mankiw.”
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    A hilarious (but perhaps only to an economist) take on the ten principles of economics.
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  5. “And the long version of the history is crucial here. It shows that for much of the 20th century, total taxes on the very wealthy were much higher than they are now. Before World War II, the average rate hovered around 70 percent. From the mid-1940s through the mid-1970s, the average rate was above 50 percent.”
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    David Leonhardt on taxing the rich in America. His newsletter is worth subscribing to, by the way.