First Principles
First Principles: A first principle is a basic proposition or assumption that cannot be deduced from any other proposition or assumption. In mathematics, first principles are referred to as axioms or postulates. In physics and other sciences, theoretical work is said to be from first principles, or ab initio, if it starts directly at the level of established science and does not make assumptions such as empirical model and parameter fitting.
If I had an hour to solve a problem I’d spend 55 minutes thinking about the problem and 5 minutes thinking about solutions
No problem can be solved by the same level of consciousness that created it.
Any fool can know. The point is to understand.
Albert Einstein
The Paradigm
First Principles thinking is a paradigm, a way of viewing the world, based on deconstructing events, actions, problems, issues, opportunities, questions, etc. into their core component elements of parts until a point is reached where no further reduction is possible. These core elements are the foundation or “first principles” of the issue at hand and form the basis for understanding.
I think it’s important to reason from first principles rather than by analogy. The normal way we conduct our lives is we reason by analogy. With analogy we are doing this because it’s like something else that was done, or it is like what other people are doing. With first principles you boil things down to the most fundamental truths…and then reason up from there.
Elon Musk
Markets & Economics
Markets are interconnected systems that can be both complex and complicated. To best understand a market ecosystem it is beneficial to start with the core elements and understand the structure and operation of the network through which these elements are linked.
To the naive mind that can conceive of order only as the product of deliberate arrangement, it may seem absurd that in complex conditions order, and adaptation to the unknown can be achieved more effectively by decentralizing decisions and that a division of authority will actually extend the possibility of overall order. Yet that decentralization actually leads to more information being taken into account.
Friedrich Hayek, Nobel Prize (Economics) 1974
Example: The First of Two Fundamental Problems With Customer Choice in Retail Electricity Markets
In most parts of Texas, residential consumers are able to choose who they purchase their electricity from and for how long. There are dozens of different Retail Electric Providers (REPs) and a consumer can choose a contract length of anywhere from one to thirty-six months (excluding the possibility of spot purchases through Griddy (see www.griddy.com)). This is a challenging structural environment for a small consumer because an informed choice would require that they evaluate billions if not trillions of options.
To see why, assume for the moment that a consumer can choose contracts of any duration from 1 to 36 months.
In this scenario the consumer has more than 34 billion options to evaluate,
2(m-1) = 34,359,738,368, where m is the max contract length
even if there is just a single Retail Electric Provider. As a result, the likelihood of a consumer finding the optimal path is statistically zero.
Furthermore, in this environment we should expect to see the existing Retail Electricity Providers introduce contracts with price/duration combinations that make it very difficult for consumers to make comparisons which makes customer switching less likely. Regardless of the specific behavior within the market by the participants, the nature of the market itself has implications regarding efficiency and competitiveness. (A blog piece deals with the other fundamental problem)
Think Before Acting
Understand what is of primary importance and the logical sequence of causation. Discern between high and low frequency signals and be able to identify noise in the system. High and low frequency signals are both important but they need to be thought about differently.
Think simple as my old master used to say – meaning reduce the whole of its parts into the simplest terms, getting back to first principles.
Frank Lloyd Wright
Law Of The Instrument
Resist the temptation to let the “tools” prescribe the problem, the process or the solution. Data, modeling, statistical analysis, econometrics, etc. are all tools. Tools are necessary but by themselves are never sufficient to understand the problem or opportunity.
Give a small boy a hammer, and he will find that everything he encounters needs pounding.
Abraham Kaplan
If all you have is a hammer everything looks like a nail.
Abraham Maslow
Reality May Appear Simple
Choose system thinking – with an emphasis on interdependency, interconnectedness, networks, structures, focusing on the whole, synthesis, emergence, feedback loops – rather than linear thinking. The world is non-linear and relying on a linear thought process is unlikely to produce the best results.
When we try to pick out anything by itself, we find it hitched to everything in the Universe.
John Muir
In nature we never see anything isolated, but everything in connection with something else, which is before it, beside it, under it and over it.
Johann Wolfgang von Goethe