Multi-Level Thinking

In poker, there is a concept called leveling or multi-level thinking.  The basic idea is that you consider the consequences (and consequences of consequences, and consequences of consequences of consequences, and so on) of what your opponents are thinking.  Here’s the basic idea from a poker site:

  • Level 0: What do I have?
  • Level 1: What does my opponent have?
  • Level 2: What does my opponent think I have?
  • Level 3: What does my opponent think I think he has?
  • Level 4: What does my opponent think I think he thinks I have?

On one hand, Poker is an interesting game because there are so many concepts that resemble real-life problems such as probabilities, deceit and bluffing, betting, folding, equity, and I’m sure numerous others.  On the other hand, it is a greatly simplified compared to more realistic problems.  For example, when do you ever know the exact probabilities of things?  When do you have such strict rules for betting/folding?  When can you be assured that the rules aren’t every going to change?  You get the idea.

Despite all these simplifications, some of the ideas can be transferable to real-world problems.  And the one I mentioned above is a great example.  Not employing multi-level thinking is a classic misjudgement when humans are confronted with complex systems (i.e. everything around us).  Actions have consequences.  Consequences have consequences.  Consequences of consequences have consequences.  You get the picture.  Here is an example of this misjudgement applied to some fictional (and simplified) scenario that I read about in Seeking Wisdom: From Darwin to Munger by Peter Bevelin.

Rats have infested campus buildings and the university is implementing a solution whereby any student who turns in a dead rat receives $1.

This worked extremely well at first — until it didn’t.  Can you think of what could possibly go wrong with this scenario?  Let’s apply some multi-level thinking:

  • Level 0: Implement policy to remove rats by paying $1 for each dead rat.
  • Level 1: Students start killing rats, rats population shrinks.
  • Level 2: Poor students want more money, start breeding rats and not killing ones roaming around campus.
  • Level 3: University still has a rat problem, is out thousands of dollars, and now has rat farms all over campus.

It’s not always possible to consider every consequence of our actions, but with a few extra steps you can prevent some really stupid decisions.

A product is about to be released to the market with little penetration.  The company increases the price of the product and sales volume skyrocketed.

This scenario is from a speech by Charlie Munger.  This is a clear example where misguided thinking might lead you into the wrong direction.  In this case, the consequence of the price increase isn’t limited to the classic micro economic explanation (increase price, lower volume).  The trick here is that even when thinking at Level 1, there are multiple possibilities.  Why could the sales have suddenly increased when the price of the product rose?  Higher price sometimes signals higher quality (e.g. luxury goods), leading to greater sales.  My favourite answer though is Charlie’s follow up, where he uses an idea from even higher level thinking: bribes.  Use some of the extra margin you make on the product to give commission to the sales guy.  He’ll push the product more (since it makes more money from him) and at the same time making more money for you.  This is a classic strategy used by Coca Cola and its distributors, as well as mutual funds and its sales reps.

Now that I’ve written about this, you might think that I’ve thought about how you’re going to perceive what I have written…  but you’d be wrong.  Instead, I’m still stuck at level 0 trying to figure out what I’m going to eat for lunch (and the consequences of it!)