Tuesday, April 24, 2007

The 80-20 Rule

The Wall Street Journal opines on Nassim Taleb's latest book. Taleb is concerned with the impact of highly unlikely events and asks the question, "What happens when normal is not average?"

We are used to taking normal an average to be about the same thing. The familiar bell curve which dominates how even the most sophisticated among us think about risk, demands that average and normal are the same thing.

Unfortunately, this is not how the world really works. Most Americans have a net worth that is significantly below average. When we look at the entire world the average person is doing OK, but most people still live in poverty.

I am continually struck by the power of power law distributions as in occupational talent. To many people a PhD is a PhD and certainly all professors are experts. Yet, the disparity of understanding within academia dwarfs the gap between academia and the outside world.

That is, if you look at the gap between how well the average economist understands the economic problem and the understanding that the very best have, its much wider that the gap between the average person and the economics profession in general. Its truly amazing to behold.

14 comments:

Dex Kaden said...

I find it quite frustrating when people use "normal" and "average" as synonyms, especially my economics professors and their "sophisticated" models.

If by "normal" we choose to mean what is typical , then what is really typical is variation. Things vary from year to year, so the average by itself just doesn't say very much about what the real world is like; the average is just a statistical result derived from a collection of events that individually may not look anything like the average.

To say anything meaningful about the world, its variability must be described.

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