Saturday Serendipity
Quote,Mental Model, Interesting find.
Hi.
Reading time: About 4 minutes
Quote
“If you understand the math behind compounding you realize the most important question is not “How can I earn the highest returns?” It’s “What are the best returns I can sustain for the longest period of time?” Little changes compounded for a long time create extraordinary changes. Same as ever.”
― Morgan Housel
Mental Model
Externalities
What are externalities?
Externalities are basically an indirect cost or gain through an uninvolved third parties actions.
“An externality is a cost or benefit that is caused by one party but financially incurred or received by another” Investopedia
In layman terms if you had a slot for an interview at 10 am and someone else had it at 12pm but you got yours shifted to 12pm as well due to some unforeseen circumstances. Your action has now affected the other persons interview. The other person had to shift their time from 12pm to 1pm which was occupied by person X. Person X has suffered due to the one small change of slot from your side.
This is an externality. Person X got affected by something not in his control.
It’s kind of like second order consequences.
One thing leads to another leads to another to another and so on.
Farnam Street wrote,
Hardin gives the example of the Prohibition Amendment in the U.S. In 1920, lawmakers banned the production and sale of alcoholic beverages throughout the entire country. This was in response to an extended campaign by those who believed alcohol was evil. It wasn’t enough to restrict its consumption—it needed to go.
The addition of 61 words to the American Constitution changed the social and legal landscape for over a decade. Policymakers presumably thought they could make the change and people would stop drinking. But Prohibition led to numerous externalities. Alcohol is an important part of many people’s lives. Few were willing to suddenly give it up without a fight. The demand was more than strong enough to ensure a black-market supply re-emerged.
Wealthy people stockpiled alcohol in their homes before the ban went into effect. Thousands of speakeasies and gin joints flourished. Walgreens grew from 20 stores to 500, in large part due to its sales of ‘medicinal’ whiskey. Former alcohol producers simply sold the ingredients for people to make their own. Gangsters like Al Capone made their fortune smuggling, and murdered his rivals in the process. Crime gangs undermined official institutions. Tax revenues plummeted. People lost their jobs. Prisons became overcrowded and bribery commonplace. Thousands died from crime and drinking unsafe homemade alcohol.
Policymakers did not fully ask, “And then what?” before legislating. Drinking did decrease during this time, on average by about half. But this was far from the hope of a total ban. The second-order consequences outweighed any benefits.
Now when we looked for solutions to second order consequences if you remember we came with a rule for asking the question ‘and then what?’ In any system there are externalities involved. They are not in your control but they sure do affect you.
Let’s look at the types of externalities.
Positive Externalities
This is when the third party gets an unexpected benefit.
This is a very silly example but a simple thing like the construction of a new bridge which saves people 10 minutes of their time can be considered as a positive externality. This is because the construction of the bridge caused more jobs, enabled more people to reach from one place to another quicker, enabled people coming back to reduce stress and improve their life by reducing travel time.
In this scenario the bridge is a positive externality.
Negative Externalities
This is the opposite of positive externalities. It is when the third part has to incur costs due to the externality.
During Covid when people went out they also carried with them the risk of having corona. While you may believe or not believe in the virus. The virus will definitely cause a lot of health problems and increase societal risk.
To increase margins many times the people try to incentivise their employees with bonuses. It works for some but for most this hilly billy has no point. Employees end up looking for other places to learn.
We know that all of our actions have certain consequences. Simply even washing your plates or being nice to someone has a lot of consequences which can only be thought of if we ask the question ‘and then what?
Interesting find
That’s it. Enjoy your weekend.
Thank you for reading,
Samvit Patel