Fads and Fortunes

While re-reading Fischer Black's Noise, I was reminded of his theory of business cycles: economics downturns are due to firms poorly estimating what people want. When this mismatching occurs at a great scale, recession hits.

Tyler Cowen isn't much of a fan of this theory; by the law of large numbers, the successes should cancel out the failures. I've argued this point with him, saying that the LLN only works if the agents are independent. It makes sense that they are not--entreprenuers don't live in vacuums. He reasonably asked, "What sort of connection between all these agents is so strong that it could intitate such a downturn?" To that I had no answer.

I still don't have one per se, but I just thought about the other side of the equation.

The LLN argument only works if both the firms and the consumers are independent. I may not be able to nail down a common link between firms but cultural exchange is something consumers do in abundence. Personally, I've been introduced to (and in some cases became obsessed with) restaurants, televison shows, movies, music, games, books, food, clothes and so forth. I've also shared most of these new wonders with others.

These sort of information linkage mechanisms create crowding around a particular good or service which leaves average or unadvertised alternatives without a market. Because Mike introduced me to Firefly, I spend time and money on it; a void is filled that I might have filled with some other substitute. Ideas that would have been consumed or supported are crowded out by more popular ones. Failure occurs; money is wasted. Fads (fashionable products that are later abandoned) aggrevate the downturn because these once-popular goods fail (thus any resources spent on expanding the line are also wasted).

This could help explain why the business failure rate for fashionable products (clothes, restaurants, television shows) is so much higher than industrial products (to which popularity plays less of a role). As someone who wrote a guide on dining in the DC area, this is an argument I'm sure Prof. Cowen can at least appreciate.