Backfiring expectations

19 September, 2015 at 18:54 | Posted in Economics | Leave a comment

Economist Brian Arthur has made important contributions to our understanding of inductive versus deductive approaches to problem solving. Arthur notes that you can solve only the easiest problems deductively … But humans are superb at recognizing and matching patterns. We’re inductive machines.

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Arthur offers a model of inductive reasoning, effectively picking up where Lord Keynes left off. The model is based on the El Farol bar in Santa Fe, New Mexico … Attending the El Farol when it isn’t too crowded is fun … But the bar is a turn-off when it is packed.

To make the problem more concrete, Arthur suggests that the bar has a hundred-person capacity and that with sixty people or fewer it is not crowded and with more than sixty it is … This problem has two notable features. First, the problem is too complicated for a deductive solution. As individuals can only look at past attendance, there are a large number of legitimate expectational models. The potential bar goers must use an inductive approach. Second, common expectations backfire. If all believe most will go, nobody will go. And if all believe nobody will go, all will go. Like Keynes’s beauty contest, the issue is not just what you believe but rather what you believe others to believe.

Michael J. Mauboussin

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