NPV Part 2: The Value of Knowledge

Once you grasp the importance of NPV, you can then grasp the value of knowledge in terms of it increasing your productivity.  From here on I will refer to ROI (return on investment) instead of NPV, since you can calculate ROI from the NPV formula, and I prefer using ROI over NPV when it comes to making the best decision.

One aspect of NPV/ROI I glossed over in the previous post was the stochastic and indeterminate nature of expected future incomes.  These future incomes determine the ROI.  However, how do we know what the future incomes will be?  Knowledge determines this.

If you’re a determinist (which I believe I am), you believe that all future outcomes are predictable to the extent that you understand the mechanics of the world (natural law) and its current conditions.  If this is the case, then out of all the choices you could possibly make (e.g. how to invest your resources), there exists a deterministic set of future incomes for each choice, and as such, a respective deterministic ROI for each. (For sake of clarity, choosing is equivalent to acting)

I will distinguish here between deterministic ROI and predicted ROI, where deterministic ROI is the ROI that is determined by nature and natural law (of which humans are among), and predicted ROI is the ROI calculated by the actor.

To the extent that the actor is knowledgeable, predicted ROI will converge to deterministic ROI.  To the extent that we are foolish, it will diverge.  When it comes time for us to act, we will choose among our options the path that has the greatest predicted ROI.  However, to the extent that we lack knowledge, our choice will be farther away from the choice with the highest deterministic ROI.  When we make our choice, we effectively miss out on the difference in wealth generated from the choice with the highest deterministic ROI and the wealth generated from the choice with the highest predicted ROI.

The more knowledgeable we are of nature, the more of this lost opportunity between deterministic and predicted ROI we will be able to grasp.  The more knowledgeable we become, the predicted ROI’s among the choices in front of us will change, and as such the optimal choice we had when we were more foolish will no longer be the optimal choice when we are more knowledgeable.  Knowledge changes how we act for the better.

Of course these choices aren’t just limited to projects for project managers to make, but to all the choices we make as individuals, as simple as what to eat and as complicated as what career to pursue.  Knowledge makes us more productive because it allows us to better recognize the outcomes of our actions, and to then choose the better option.

2 thoughts on “NPV Part 2: The Value of Knowledge”

  1. Agreed with the premise, but in practical application, all knowledge is finite and failing to remember that leads us into error. This is why communism doesn’t work out- efficient central planning is impossible at scale in the real world. But our “better knowledge makes better choices” model also breaks down in the time dimension. What is perfectly true right now may not be true at all in X moments.

    If I put my hands HERE positioned SO right NOW; I catch the baseball. A moment later, or earlier, I flub the catch. Technique was flawless, timing was off.

    1. Well, when it comes to truths (natural laws), the definition I prefer, are those things that are true today, always have been true, and always will be true. An example would be simply 2+2=4. This is something that we can believe will always be true. The reaction of gasoline and oxygen under STP will always be exothermic and produce pressure. The car designer/entrepreneur can rely on this truth to engineer an engine that will take in gasoline to power the car. That way when they build the car, they know it will work in the future because the functioning of the car relies on natural laws that are time invariant.

      Of course, making observations of the world, is simply another aspect of nature we can be knowledgeable of (i.e. where and how materials are arranged, not just their mechanics), so that we can apply the right technique to the right situation.

Leave a Reply

Your email address will not be published. Required fields are marked *