A video explaining Exponential Growth by Rolf Dobelli the author of The Art of Thinking Clearly on the IDFC Mutual Fund Youtube Channel.
What is Exponential Growth? And being stumped by a sheet of paper
Consider the following 2 tasks:
A piece of paper is folded in two, then in half again, again and again.
How thick will it be after 50 folds? Write down your guess before you continue reading.
Choose between these options:
A) Over the next 30 days, I will give you $1,000 a day.
B) Over the next 30 days, I will give you a cent on the first day, two cents on the second day, four cents on the third day, eight cents on the fourth day, and so on.
Don’t think too long about it: A or B?
Are you ready?
Well, if we assume that a sheet of copy paper is approximately 0.004 inches thick, then its thickness after 50 folds is a little over 60 million miles. This equals the distance between the earth and the sun, as you can check easily with a calculator.
With the second question, it is worthwhile choosing option B, even though A sounds more tempting. Selecting A earns you $30,000 in 30 days; choosing B gives you more than $5 million.
Linear growth and our past
Linear growth we understand intuitively. However, we have no sense of exponential (or percentage) growth. Why is this? Because we didn’t need it before. Our ancestors’ experiences were mostly of the linear variety. Whoever spent twice the time collecting berries earned double the amount. Whoever hunted two mammoths instead of one could eat for twice as long. In the Stone Age, people rarely came across exponential growth. Today, things are different.
Here’s an example
‘Each year, the number of traffic accidents rises by 7%,’ warns a politician.
Let’s be honest: we don’t intuitively understand what this means. So, let’s use a trick and calculate the ‘doubling time’.
Start with the magic number of 70 and divide it by the growth rate in percent.
In this instance: 70 divided by 7 = 10 years.
So what the politician is saying is: ‘The number of traffic accidents doubles every 10 years.’
Pretty alarming. (You may ask: ‘Why the number 70?’ This has to do with a mathematical concept called logarithm)
Here’s another example
‘Inflation is at 5%.’
Whoever hears this thinks:
‘That’s not so bad, what’s 5% anyway?’
Let’s quickly calculate the doubling time: 70 divided by 5 = 14 years.
In 14 years, a dollar will be worth only half what it is today – a catastrophe for anyone who has a savings account.
A third example
Suppose you are a journalist and learn that the number of registered dogs in your city is rising by 10% a year.
Which headline do you put on your article?
‘Dog registrations increasing by 10%.’
No one will care.
‘Deluge of dogs: twice as many mutts in 7 years’ time!’
Nothing that grows exponentially grows forever
Most politicians, economists and journalists forget that. Such growth will eventually reach a limit. Guaranteed.
For example, the intestinal bacterium, Escherichia coli, divides every twenty minutes. In just a few days it could cover the whole planet, but since it consumes more oxygen and sugar than is available, its growth has a cut-off point.
The ancient Persians were well aware that people struggled with percentage growth
Here is a local tale:
There was once a wise courtier, who presented the king with a chessboard. Moved by the gift, the king said to him: ‘Tell me how I can thank you.’ The courtier replied: ‘Your Highness, I want nothing more than for you to cover the chessboard with rice, putting one grain of rice on the first square, and then on every subsequent square, twice the previous number of grains.’ The king was astonished: ‘It is an honour to you, dear courtier, that you present such a modest request.’
But how much rice is that? The king guessed about a sack. Only when his servants began the task – placing a grain on the first square, two grains of rice on the second square, four grains of rice on the third, and so on – did he realise that he would need more rice than was growing on earth.
When it comes to growth rates, do not trust your intuition. You don’t have any. Accept it. What really helps is a calculator, or, with low growth rates, the magic number of 70.
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The above article is from the book The Art of Thinking Clearly by Rolf Dobelli. The article is only for educational and informative purposes to explain and understand cognitive biases. It is a great book, definitely worth a read!