Tuesday, November 7, 2017

Power Laws: “The greatest shortcoming of the human race is our inability to understand the exponential function.”

From Farnum Street:

Power Laws: How Nonlinear Relationships Amplify Results

“The greatest shortcoming of the human race is our inability to understand the exponential function.”
— Albert Allen Bartlett
Defining A Power Law
Consider a person who begins weightlifting for the first time.

During their initial sessions, they can lift only a small amount of weight. But as they invest more time, they find that for each training session, their strength increases a surprising amount.

For a while, they make huge improvements. Eventually, however, their progress slows down. At first, they could increase their strength by as much as 10% per session; now it takes months to improve by even 1%. Perhaps they resort to taking performance-enhancing drugs or training more often. Their motivation is sapped and they find themselves getting injured, without any real change in the amount of weight they can lift.

Now, let’s imagine that our frustrated weightlifter decides to take up running instead. Something similar happens. While the first few runs are incredibly difficult, the person’s endurance increases rapidly with the passing of each week, until it levels off and diminishing returns set in again.
Both of these situations are examples of power laws — a relationship between two things in which a change in one thing can lead to a large change in the other, regardless of the initial quantities. In both of our examples, a small investment of time in the beginning of the endeavor leads to a large increase in performance.

Power laws are interesting because they reveal surprising correlations between disparate factors. As a mental model, power laws are versatile, with numerous applications in different fields of knowledge.
If parts of this post look intimidating to non-mathematicians, bear with us. Understanding the math behind power laws is worthwhile in order to grasp their many applications. Invest a little time in reading this and reap the value — which is in itself an example of a power law!...

HT: Value Investing World