Most things increase in demand as they get cheaper — as the price of electric cars comes down we can expect more people to buy more of them. Veblen goods are the opposite. They thrive on exclusivity. Veblen goods are more desirable exactly because they are more expensive. If everyone could buy a Rolex, the vintage whisky, or that supercar, then they wouldn't seem so super anymore. Many luxury items are veblen goods.

The I Am Rich iPhone app briefly sold for $999.99 and displayed only a glowing red gem and a mantra about being rich. Genius/madness.

Veblen goods are named after Thorstein Veblen, coiner of the concept of conspicuous consumption.

Veblen goods

Fungible goods are mutually interchangeable in that, in principle, you could swap in any unit for any other unit of the same type or kind and it would be equivalent. Money is a classic fungible good. A $10 bill is equivalent to any other $10 bill, so if you were to borrow $10 from someone they wouldn't care or expect to get the same $10 bill back.

Non-fungible goods are unique and not mutually interchangeable. Each house, even cookie-cutter houses, is in a unique location, with different neighbours, quirks, and history. Having a print of the Mona Lisa on your wall is not the same as having the original from the Louvre. And swapping people between teams at work, even people with similar experience, will still result in different outcomes.

A nice thought experiment to distinguish fungible and non-fungible goods is to ask if you were to borrow one, would it make a difference if you returned a different one? So if you were to borrow my car, you could return it to me with a different tank of fuel (a fungible good) and it wouldn't make any difference to me. But if you were to return a different used car (a non-fungible good) that would be rather odd.

In case you've heard of NFTs (Non-Fungible Tokens) and would like to understand their flaws and promise better I recommend the NFT Freakonomics episode of the 3-part series What can Blockchain do for you?

Fungible - non-fungible

A swan in Europe was a white swan. So, naturally, swans were thought of as only white by Europeans until news came from travelers to Australia in the late 1600s where black swans are in fact relatively common. Black swan events can turn a worldview upside down. They are unprecedented, unexpected, rare, and with a significant impact.

The infrequency of black swan events means prior data about them is too little to reliably guess the likelihood of one, and you may not even think to anticipate the event anyway. Except after the fact, when all of a sudden many people will claim to have predicted it — black swan events are prone to be rationalised in hindsight, believing that all the signs were there beforehand even if they weren't.

The idea of black swan events is from Nassim Nicholas Taleb. He writes:

"One single observation can invalidate a general statement derived from millennia of confirmatory sightings of millions of white swans. All you need is one single black bird."

Examples Taleb gives include the September 11 terrorist attack, the 2008 financial crisis, World War I, or the rise of the Internet.

More Taleb sketches: on mistakes, the firehouse effect, and the Lucretius problem. Also, hindsight bias.

Black swan events

Physics envy refers to the wish that a field of study would turn out to be as precise, as predictable, as repeatable, and as amenable to modeling and theory that replicates practice as physics is.

As it turns out, most fields that involve people — such as economics and the social sciences — are rarely so tidy and orderly and neatly mathematically modeled. They are instead usually messy, uncertain, and filled with context, nuance, history and confounding factors such that making sense of them in broadly applicable ways is rather difficult. And while we do our best to quantify and identify effects, or cleanly isolate our cognitive biases or our quirks of behavioural psychology, rarely are they able to live up to the purest standards of physics. It's enough to turn one green with envy.

It reminded me of the best laid plans of our Saturday sports coaches turning for their substitutes to execute their plans, only to find the players climbing trees in the adjacent field.

Physics Envy

The Gini coefficient, or Gini index, is a common way to gauge income or wealth inequality within a population.

The coefficient gives a single number showing how equal a distribution is. For example, in a population where everyone earns the same amount the Gini coefficient would be 0 — total equality — and in a population where one person earned all of the population's money, the Gini coefficient would be 1 (sometimes expressed as 100%) — maximum inequality. In practice all countries' Gini coefficients are somewhere in between, at around 0.25 to 0.5 after taxes.

Like any simple measure the Gini has its difficulties, like being easily misinterpreted when compared, but is still widely used. The BBC has a short piece on its history and an alternative measure called the Palma ratio.

Of course, we have some high profile zillionaires at the moment. You might like this old sketch of wealth inequality in America.

The Gini coefficient

I've been there. I'm holding some packaging that kind of looks like it ought to be recyclable but isn't one of the standard products that are asked for. I could put it in the bin and then it'll head straight to landfill, or I could put it in the recycling and then it has a chance of being recycled, right? So it often seems better to recycle it in the hope that it might be recovered rather than consign it to certain landfill. This is known as wishcycling.

Sadly, from all that I've read about wishcycling it's not the best approach. When we put in non-recyclables into a recycling bin it contaminates the high quality recyclable materials and several things can happen:

A lot of dry recycling is still manually sorted in Materials Recovery Facilities (MRFs). When the quality of the input goes down it can require more people to sort it. It's not a pretty job if it also contains items that are contaminated with food waste

Non-recyclable items that processing machines aren't designed for can damage them and mean costly maintenance

Items like batteries that make it into regular recycling can start fires in paper bales which is dangerous and expensive

Non-recyclables mixed in can mean a lower quality end product to use to turn into new products. This can reduce what it can be used for and make it harder to sell

Paying more pickers and sorters and servicing machines costs money, and selling lower quality products brings less in, both of which reduce the profitability and potential viability of recycling operations

So the advice I have learned to take on board is:

Counterintuitively, if we want to recycle more, it seems at the moment we have to recycle less.

And even better is to reduce and reuse where possible in the first place.

Wishcycling

How small changes in customer demand can produce considerable disruption upstream in the supply chain. For instance, a sudden surge in the buying of toilet paper may cause retailers to put in larger orders to make sure they can keep up with demand. Manufacturers, in turn, may put in even larger orders for raw materials to make sure they don’t get caught out. In the meantime, customers had bought all the toilet paper they ever needed and demand suddenly dropped causing retailers to cancel all their orders, manufacturers to halt production and suppliers to be left with big stockpiles of unwanted raw materials.

I learned about the bullwhip effect from Tomas Tunguz where he considers economic effects of the coronavirus. He explains it with a brewery example in his article on proxy metrics for startups.

The Bullwhip Effect

This simple model for the progression of ideas is sometimes called a dialectic. It has many philosophical roots, but regardless it’s a nice way to think of how ideas, and perhaps society can progress. Something is created or put forward. It has some benefits but gives rise to negative effects and somehow we figure out a resolution as progress. That new solution then becomes the basis for the next step.

In engineering I learned that we progress by the resolution of contradictions. As a very simple example, it’s nice to have a walking stick. But a full-length walking stick is difficult to transport. You want it to be long when you’re walking, and short when you’re traveling with it. So we invent retractable ones. But retractable ones break more easily, so we invent…to be determined.

You also see a similar idea in stories, for example, the story spine.

It’s sometimes erroneously called Hegel’s dialectic, perhaps partly because Hegel’s work was sometimes so difficult to grasp and this is nicely simple.

Thesis, antithesis, synthesis

You might think that adding more of a good thing would make things better. And, yes, that’s often true, up to a point. However, the law of diminishing returns suggests that as you add more of a single factor, you are likely to yield progressively lower benefits.

It’s like the old adage, “Too many cooks spoil the broth.” Another cook or two might help, but beyond that, they’ll probably start getting in each other’s way. Aside from cooking broth, you might see the law play out in spending on advertisements, quality improvements in production or your wealth.

And we should also never forget that “more is different”.

The sketchplanation is a homage to perhaps my favourite comedy sketch with an early-career Simon Pegg in the series Big Train: the cake factory (video). Well worth two and a half minutes.

Law of diminishing returns

The story goes something like this. Back in colonial India the top Brit in charge decided there were too many cobras around Delhi. To reduce the population they put in place a cash reward, or bounty, for anyone who brought in a dead cobra. The intention was clear. Legend has it that people did bring in the cobras reliably because some enterprising souls had started breeding cobras for the very purpose of getting the bounty. When the authorities realised this they scrapped the scheme, the cobra farms closed and the bred cobras were released into the wild significantly increasing the cobra population by a few orders of magnitude. Hence, the cobra effect: when a well-intentioned measure can have the opposite effect to that desired.

It’s not clear how true this story is, but the cobra effect has been demonstrated many times. The Freakonomics podcast on the cobra effect discusses some excellent examples (with references), including:

A bounty on rats in French colonial Hanoi — where the bounty was earned by bringing in a rat tail — which went the same way as the cobra story

Removing wild pigs at Fort Benning, Georgia, at $40 a pigs tail that didn’t make a dent. It could be the hunters would bait the pigs with all sorts of tempting scraps. Many pigs learned to avoid the hunters and instead bred like crazy while well-fed on scraps.

The capital of Colombia, Bogotá, tried to reduce traffic congestion by restricting each car from driving one day during the week. The result: people started buying more than 1 car and did more driving on weekends.

Publication of proposed areas of habitat to be protected for endangered species meant land developers responded by building in those areas before the land was protected.

People are smart. Incentives work, in the sense that you tend to get what you incentivise. So be careful what you are incentivising.

Also see: Goodhart’s Law and What gets measured gets better.

The cobra effect

I grew up with the idea that there are developed countries and developing countries. There was the ‘rich’ world and the ‘poor’ world. I didn’t actively consider it. It’s just always been there. And it’s wrong.

In his excellent book Factfulness, Hans Rosling shows that wealthier countries tend to have smaller families and a low child mortality rate. In contrast, poorer countries are more likely to have larger families and a high child mortality rate. Plotting the spread of countries in 1965 gives a reasonable approximation of a cluster of ‘developed’ countries with small families where most children survive and a cluster of ‘developing’ countries with larger families where more children die. But that was in 1965.

The world has changed a lot since then, and that model of dividing the world into two buckets no longer holds true with the data. Most people in the world are somewhere in the middle.

And more helpful than dismantling my worldview was providing a new model to replace it: a model with 4 income levels instead of 2 and the number of billions of people living at each level. It’s a model with most people somewhere in the middle.

For more, check out the Factfulness book, or Gapminder. And you could do much worse than watch Hans’ entertaining TED talk: the best stats you’ve ever seen.

A world of 4 income levels

Back in 1865, a chap called William Stanley Jevons noted that while there had been a number of improvements in coal efficiency in steam engines and the like, instead of reducing consumption the effect was to increase consumption instead — Jevon's paradox.

While it’s not a surefire outcome, there are plenty of parallels like more efficient batteries leading to more overall battery use, washing machines leading to doing more washes rather than less time spent washing, or the ability to recycle some plastics leading to more overall plastic consumption.

This is sometimes known as the rebound effect.

Also see the fifth fuel: energy efficiency, and save some landfill.

Jevon’s Paradox

There don’t seem to perfect definitions for either recessions or depressions. A recession is commonly defined as two successive declining quarters of GDP, but it’s not gospel. And a depression is a kind of prolonged recession for 3–4 years. So I liked Harry Truman’s clarifying explanation — US president from 1945–1953:

A recession is when your neighbour loses his job.  A depression is when you lose yours.  —Harry Truman 

Recession vs depression

This is surely at least part of the reason that “software is eating the world.”

But I’m sure coffee will stick around for a bit too.

Sketchplanations tagged with economics