Surfacing big ideas from big disciplines
11 mental models this week — read on below for the articles and definitions:
- Information asymmetry
- Adverse selection
- Mr.Market
- Moats
- Aggregators
- Platforms
- Network Effects
- Ecological Niche
- Fundamental Attribution Error
- Attractors
- Entropy
ICOs and Economics of Lemon Markets
Full Write Up: Economics of Initial Coin Offerings
Information Asymmetry
This occurs in transactions where one party has more or better information than the other.
This asymmetry creates an imbalance of power in transactions, which can sometimes cause the transactions to go awry, a kind of market failure in the worst case (Wikipedia, World Bank)
Adverse selection
Strategic behavior (selective participation) by a more informed participant in an exchange against the interest of the less informed participant(s)(How Adverse Selection Affects the Health Insurance Market)
put another way: [this] describes an undesired result due to the situation where one party of a deal has more accurate and different information than the other party. The party with less information is at a disadvantage to the party with more information (Investopedia)
Mr. Market
[Benjamin] Graham believed stock market fluctuations were irrational and generally based on greed and fear. He invented the hypothetical character of Mr. Market as a parable to demonstrate his philosophy (ValueWalk)
put another way: participants in the stock market are humans subject to the corroding influence of emotions.
Investors are frequently given to bouts of over-optimism and greed, which causes stock prices to be bid up to very high levels. These same investors are also vulnerable to excessive pessimism and fear, in which case, stock prices are driven down substantially below intrinsic value (Morningstar)
Stratechery — The Moat Map
Moats
Warren Buffett, the chairman of Berkshire Hathaway, has emphasized over the years that he looks for businesses with sustainable competitive advantages.
He suggests that buying a business is akin to buying a castle surrounded by a moat. Buffett wants the economic moat around the businesses to be deep and wide in order to fend off all competition.
He goes a step further by noting that economic moats are almost never stable. Moats either get a little bit wider or a little bit narrower every day. (Measuring the Moat — Michael Mauboussin)
Aggregators
Aggregation is fundamentally about owning the user relationship and being able to scale that relationship; these businesses have all three of the following characteristics
- Direct relationship with users
- Zero marginal costs for serving users
- Demand-driven multi-sided networks with decreasing acquisition costs (Stratechery)
Aggregators attract end users by virtue of their inherent usefulness and, over time, leave suppliers no choice but to follow the aggregators’ dictates if they wish to reach end users (Stratechery)
Platforms
Platforms, though, while established through product leadership, flourish and sustain themselves by empowering and entrusting developers to build something so compelling that customers fall in love with not just the hardware but the experience that runs on top of it. In short, they require sharing the customer relationship (Stretechery)
Platforms need 3rd parties to make them useful and build their moat through the creation of ecosystems (Stratechery)
Network effects
A network effect (a.k.a. demand-side economies of scale) occurs when a product or a service becomes more valuable to its users as more people use it (a16z)
Melting Asphalt — Ecological Thinking
Ecological niche
A species’ niche is its ecological role or “way of life,” which is defined by the full set of conditions, resources, and interactions it needs or can make use of. Each species fits into an ecological community in its own special way and has its own tolerable ranges for many environmental factors (Khan Academy)
Fundamental attribution error
Our tendency to explain others’ behavior in terms of their character (or other internal factors), rather than taking into account external (situational) factors (Edge.org, Wikipedia)
put another way: Modern scientific psychology insists that explanation of the behavior of humans always requires reference to the situation the person is in. The failure to do so sufficiently is known as the Fundamental Attribution Error….overestimating the role of traits and underestimating the importance of situations (Edge.org)
Attractors
In dynamical systems, an attractor is a value or set of values for the variables of a system to which they will tend towards over enough time, or enough iterations (Santa Fe Institute)
put another way: a state toward which a system tends to evolve, for a wide variety of starting conditions of the system (Wikipedia)
put one more way: The inherent properties of complex adaptive systems make the exact trajectories of these systems unforeseeable. However, since the systems unfold into a common direction, we can say something about the qualities of the milestones toward which these systems navigate. Attractors configure the evolution of complex adaptive systems. Since attractors are the most stable and robust elements in these systems (Science Direct — Exposing the attractors of evolving complex adaptive systems by utilising futures images: Milestones of the food sustainability journey)
Entropy Explained, With Sheep
Entropy
Entropy is just a fancy word for ‘number of possible arrangements’. Entropy is a count of how many ways you can rearrange the ‘insides’ of a thing (its microscopic internals), while keeping its ‘outwardly’ (macroscopic) state unchanged.
The odds of seeing entropy decrease are effectively zero, not because any physical law compels it to be so, but because of sheer statistics — there are overwhelmingly more ways for the energy to be spread out than there are ways for the energy to be contained.
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