Chaos Theory and Decision Making
Chapter 12 in
David Jennings and Stuart Wattam (2000)
"Decision Making - An Integrated Approach" : Pitman Publishing
Key points in this chapter :
Ñ The Beginning of Chaos Theory
Ñ Developments in the Chaos Theory
Ñ Chaos in Business Decision Making
Ñ Some Key Terms
What exactly is chaos? Put simply, it is the idea that it is possible to get completely random results from normal equations. Chaos theory also covers the reverse: finding the order in what appears to be completely random data.
The Beginning of Chaos Theory
When was chaos first discovered? The first true experimenter in chaos was a meteorologist, named Edward Lorenz. In 1960, he was working on the problem of weather prediction. He had a computer set up, with a set of twelve equations to model the weather. It didn't predict the weather itself. However this computer program did theoretically predict what the weather might be. One day in 1961, he wanted to see a particular sequence again. To save time, he started in the middle of the sequence, instead of the beginning. He entered the number off his printout and left to let it run.
When he came back an hour later, the sequence had evolved differently. Instead of the same pattern as before, it diverged from the pattern, ending up wildly different from the original. Eventually he figured out what happened. The computer stored the numbers to six decimal places in its memory. To save paper, he only had it print out three decimal places. In the original sequence, the number was .506127, and he had only typed the first three digits, .506.
By all conventional ideas of the time, it should have worked. He should have gotten a sequence very close to the original sequence. A scientist considers himself lucky if he can get measurements with accuracy to three decimal places. Surely the fourth and fifth, impossible to measure using reasonable methods, can't have a huge effect on the outcome of the experiment. Lorenz proved this idea wrong. This effect came to be known as the butterfly effect. The amount of difference in the starting points of the two curves is so small that it is comparable to a butterfly flapping its wings.
The flapping of a single butterfly's wing today produces a tiny change in the state of the atmosphere. Over a period of time, what the atmosphere actually does diverges from what it would have done. So, in a month's time, a tornado that would have devastated the Indonesian coast doesn't happen. Or maybe one that wasn't going to happen, does. (Ian Stewart, Does God Play Dice? The Mathematics of Chaos, pg. 141)
This phenomenon, common to chaos theory, is also known as sensitive dependence on initial conditions. Just a small change in the initial conditions can drastically change the long-term behavior of a system. Such a small amount of difference in a measurement might be considered experimental noise, background noise, or an inaccuracy of the equipment. Such things are impossible to avoid in even the most isolated lab. With a starting number of 2, the final result can be entirely different from the same system with a starting value of 2.000001. It is simply impossible to achieve this level of accuracy - just try and measure something to the nearest millionth of an inch!
From this idea, Lorenz stated that it is impossible to predict the weather accurately. However, this discovery led Lorenz on to other aspects of what eventually came to be known as chaos theory.
Developments in the Chaos Theory
Another system in which sensitive dependence on initial conditions is evident is the flip of a coin. There are two variables in a flipping coin: how soon it hits the ground, and how fast it is flipping. Theoretically, it should be possible to control these variables entirely and control how the coin will end up. In practice, it is impossible to control exactly how fast the coin flips and how high it flips. It is possible to put the variables into a certain range, but it is impossible to control it enough to know the final results of the coin toss.
A similar problem occurs in ecology, and the prediction of biological populations. The equation would be simple if population just rises indefinitely, but the effect of predators and a limited food supply make this equation incorrect.
An employee of IBM, Benoit Mandelbrot was a mathematician studying this self-similarity. One of the areas he was studying was cotton price fluctuations. No matter how the data on cotton prices was analyzed, the results did not fit the normal distribution. Mandelbrot eventually obtained all of the available data on cotton prices, dating back to 1900. When he analyzed the data with IBM's computers, he noticed an astonishing fact:
The numbers that produced aberrations from the point of view of normal distribution produced symmetry from the point of view of scaling. Each particular price change was random and unpredictable. But the sequence of changes was independent on scale: curves for daily price changes and monthly price changes matched perfectly. Incredibly, analyzed Mandelbrot's way, the degree of variation had remained constant over a tumultuous sixty-year period that saw two World Wars and a depression. (James Gleick, Chaos - Making a New Science, pg. 86)
One mathematician, Helge von Koch, captured this idea in a mathematical construction called the Koch curve. To create a Koch curve, imagine an equilateral triangle. To the middle third of each side, add another equilateral triangle. Keep on adding new triangles to the middle part of each side, and the result is a Koch curve. A magnification of the Koch curve looks exactly the same as the original. It is another self-similar figure.
Fractal structures have been noticed in many real-world areas, as well as in mathematician's minds. Blood vessels branching out further and further, the branches of a tree, the internal structure of the lungs, graphs of stock market data, and many other real-world systems all have something in common: they are all self-similar.
Chaos in Business Decision Making
A business example of the butterfly effect is that of competition in the UK between the rival video recording systems of VHS and Betamax. Though they were both technically comparable with similar price and quality levels, the VHS became the standard for the industry due to the availability of slightly more films available on VHS than on Betamax. This in turn led to more incentive for video libraries and video recorders to stay with the VHS. In business, just as in weather forecasting, a very slight difference in initial conditions can have a very major impact on the long run pattern of behavior.
The rational model of decision making process was based on a set of beliefs about the 'clockwork' nature of decision making process and the general environment in which it takes place. Chaos theory describes a different world in which these views have to be discarded and the true dimensions of uncertainty have to be acknowledged.
Some Key Terms
Discontinuities: abrupt unpredictable changes not based on previous data
Fractal: a shape which despite constant magnification retains it's geometric properties
Iteration: a sequence of calculations based on prior calculations for which the computer is particularly well suited
Strange attractors: pictures which describe the behavior of chaotic systems.
Chaos has already had a lasting effect on science, yet there is much still left to be discovered. Many scientists believe that twentieth century science will be known for only three theories: relativity, quantum mechanics, and chaos. Aspects of chaos show up everywhere around the world, from the currents of the ocean and the flow of blood through fractal blood vessels to the branches of trees and the effects of turbulence. Chaos has inescapably become part of modern science and business decision making as well. It is quite important for international business decision makers to accept and realize the importance of uncertainties of modern business environment and to give chaos theory the importance that it has been denied so far.
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