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All about the Pareto principle

At the turn of the 20th century, an Italian economist noted a very interesting trend. His name was Vilfredo Pareto, and his findings resulted in one of the most enduring principles today. He noted that in his native Italy, the wealth distribution was very unfair. There was a lot of wealth, but the people who controlled it were only very few. He realized that 20 per cent of the people in the country controlled 80 per cent of the wealth that was there. It turned out this was not an Italian problem as many other people sensed it in their countries. This was in 1906.

40 years later, a doctor Joseph M. Juran also noted his. His research led him to the works of Pareto, and he decided to name this the Pareto principle. The naming of the principle has been a controversial topic throughout history. Some even go as far as suggesting that people simply found the name Pareto better sounding than calling it the Juran principle. However, the truth of the principle cannot be denied by anyone, and it is not just in terms of wealth distribution. This economic principle has grown to become one of life’s enduring principles.

Dr Juran was an expert in the field of quality management. He worked in the United States in the thirties and forties. His work was not adequately documented, so for many people, it appeared like he had simply borrowed the work of fellow economist Pareto. He came up with what he called the vital few and trivial many principal. Where he found that only a vital few contributed real progress to most matters he studied. This principle was reduced to the 80/20 principle, but only as a symbolism. Not everything has to be strictly in the 80 and 20 per cent ratio. Sometimes, things will not even add up to a hundred.

So why is this principle so important and why is it still regarded as highly so many years later? The answer to that question is simple. The principle is not only an economic one but can be applied to many aspects of life. Knowing that in every setting, there will only be a meager 20 per cent that is vital and another trivial 80 per cent helps. A project manager that understands that 20 per cent of their work matters will learn to concentrate on the 20 that actually does matter. In most projects, the beginning ten and the last ten percent of the work will be the most crucial in the overall success of proceedings.

Knowing this fact changes everything, especially in a project. It is the source of the famed work smart principle. It translates as far as the personal life, where if one finds the 20 per cent of their life that contributes the most to their well being, they will end up with a fruitful life. This principle is now being applied in management, in a quest to produce what management experts are calling the superstar manager.

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What is the prisoners’ dilemma?

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The prisoners’ dilemma is an interesting game and theory. It is one of the most common things for economics students. It normally involves two thieves, both arrested for a crime and then separated into different isolation cells. They do not have contact with each other and this presents the prosecutors with a good opportunity. A tricky offer is then given to both of them. They are given the option of either confession or remaining silent. However, these offers come with a twist. If one of them confesses and the other remains silent, then the one who confessed will be set free and the one who remained silent will have to serve time in prison. If both of them confess, they are both convicted. However, the prosecutor offers to give them both a shortened sentence. The third option is for them both to remain silent, and this leaves them with the option of serving minimum prison sentences. Each of them remains conflicted between betraying their accomplice not knowing what they will do. If they both do not do anything, they both only stay in jail for a minimum sentence. The story goes that the prosecutor gives them a night to ponder the consequences of the decisions they will make, expecting a note in the morning.

The dilemma here comes from the fact that no one knows what the other will decide. Considering individualism, each of them will be better off if they confess. But this is only if the other remains silent in case they do. If both of them happen to confess, the outcome will be worse for each of them than it would be if both of them remained silent. This is a classic conflict between the rationalities of group and individualism. This game theory, however, can be adapted to various situations and conditions.

The prisoners’ dilemma has useful applications in life and in business. It helps one understand the differences between cooperation and competition, the rules that govern these situations. If for instance, two firms are selling the same type of product. These two firms have each have a superior market share than their competition. A similar case to the prisoners’ dilemma can be seen here. It could be useful for them if they cooperate and both sell their products at an industry high price. However, one of them might choose to benefit at the expense of another by pricing their product lower.

This phenomenon can also be seen if there are two superpower companies. They are better off collaborating in terms of military and arms strength, for instance. This keeps both of them at the helm. However, there is also the option of one of them arming themselves heavily and undermining the other.

An interesting study done on actual prisoners gave people a totally unexpected result than they had hoped for. Students from the University of Hamburg tested women prisoners with this game and compared the results to those of studies done on students for show. Interestingly, they found that the prisoners tended to cooperate more than the students.

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Why economics matters

Economics deals with how people gain grow and utilize resources. The world is full of resources, and everyday people make decisions on how they will increase their capacity, preserve it or use it to further gain themselves. Life deals with resources such as time, personal ability, buildings and other equipment. People are constantly making decisions about how to utilize these resources without realizing how they tie into the bigger picture economics. We make choices on how much time we devote to our schoolwork or careers, sports and leisure, and time to relax and unwind. People make decisions on how much they spend on food and clothing, and how much they save after taking care of the mandatory things like paying taxes.

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Most of the time, people tend to believe that economics deals with how the government handles its finances. However, individual behavioral patterns determine the economic direction taken by a country. Economics should not be thought of as a topic for the experts but as sets of everyday principles for the common individual. Historical definitions of the term economics by experts seem to point to this factor. In his 1890 book, Alfred Marshall defines economics as the field of study that investigates how people act when dealing with the business of life. Lionel Robbins in 1932 defined it as the study of how people reacted to having scarce resources they had to distribute among their alternative needs. In 1948, Samuelson defined it as the study of how people and societies used their meager resources to produce commodities of value and distribute them among themselves.

Economics are always in the job because of their ability to optimize the usage of resources. The amount of resources that are available for use for us today is constantly diminishing. This calls for effectiveness and efficiency when utilizing resources. Economic principles help in guiding the society through the optimization of resources and the reduction of wastage.

Economics also helps plan the national economy. Principles like opportunity cost are often utilized when making economic plans. One must understands the differences between societies putting money into their economy without any profits or with only losses and the implications growing the output would have. Opportunity cost involves the calculation of the loss the society gets into when they make one decision over another. It is a simple exclusion theory, and when used correctly maximizes profits. The best decisions are the ones with the least opportunity costs.

The economic stability of a country and society affects a lot of thing. One needs only refer to the effect of the 2008 recession. Monetary value flops caused widespread effects like the loss of income and livelihoods. There were only a few countries that were able to shield their citizens from the effect of the recession.

At the end of the, perhaps the biggest importance of economics has to do with individual economics. People make decisions based on their economic implications all the time. This is not to say everyone should go out and learn the principles of economics in school. People must, however, learn the practices that will keep them away from debt, bankruptcy and so on.

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