Imagine swimming alongside a moving boat. Despite your best efforts, it feels like you’re barely moving. But, are you actually moving? Yes. In the physical world, you’re advancing, but the boat is moving faster, making your movement seem negligible.
This is just one example of how our perceptions change dramatically based on context and perspective. Mental models, like Albert Einstein’s theory of relativity, are the knowledge frameworks we use to simplify big ideas, making them easier to grasp and use. Applying mental models to your business can help you navigate challenges and identify opportunities.
Here’s what mental models are, how they help us explain things, and how to use them to improve your decision-making and problem-solving processes.
Table of contents
What are mental models?
Mental models are internal representations you can use to interpret, predict, and understand life and the world around you. They simplify complex concepts, help you process information, make decisions, and solve problems more effectively. These models shape perceptions, influence behavior, and provide a structured way of thinking about various scenarios.
Charlie Munger, businessman and Warren Buffet’s right-hand man, believed that worldly wisdom came from understanding key principles from a wide range of disciplines, as no single concept can capture the world’s complexity. He advocated for weaving diverse ideas to create a “latticework” of mental models. The idea is that by examining a decision from multiple angles, you can avoid biases, reduce errors, and make more informed, well-rounded choices.
10 common mental models
- Comparative advantage
- Confirmation bias
- Efficient market hypothesis
- Game theory
- Inversion principle
- Law of diminishing returns
- Occam’s razor
- Opportunity cost
- Supply and demand
- Survivorship bias
Looking to combine your own set of ideas to create a latticework of mental models? Here are a few mental models you might find helpful:
1. Comparative advantage
Developed by the British economist David Ricardo in 1817, the theory of comparative advantage explains how companies or countries can produce goods or services more efficiently than their competitors. This principle promotes specialization, encouraging each business to focus on what they do best.
You can apply this mental model to determine which tasks to keep in-house and which to outsource. For example, if a third-party provider handles your business’s shipping and fulfillment more efficiently than you, they hold an advantage. Outsourcing frees up your team to concentrate on core strengths like product development and branding.
2. Confirmation bias
Confirmation bias is people’s tendency to look for information reinforcing their existing beliefs while overlooking contradictory evidence. It can lead to poor decision-making, like clinging to ineffective marketing strategies for underperforming products simply because they’ve worked before.
To avoid falling into this trap, base decisions on data and actual facts rather than instincts. Use A/B testing to find the winning tagline, call to action, or landing page design, and let the results challenge your assumptions. It’s also important to foster a company culture that welcomes questioning the status quo so employees can help flag instances of confirmation bias.
3. Efficient market hypothesis
The efficient market hypothesis is an economic model positing that the unit price of a particular good or stock is entirely determined by the information available at any given time.
In other words, a competitive market can always evaluate companies accurately. If true, no business could consistently outperform the overall market. This model can help you set competitive prices while encouraging a focus on long-term growth and value creation, rather than attempting to outsmart the market.
4. Game theory
Game theory is a mathematical framework for analyzing strategic interactions where each participant’s outcome depends on the actions of others. It’s like trying to figure out the best move in a game of chess, knowing your opponent can respond in ways that alter the outcome. The goal is to figure out how to win while factoring in the other player’s likely actions.
Businesses use it to anticipate competitor and customer behavior. For example, if a competitor lowers prices, you might use this mental model to decide whether to match the price, differentiate your product, or justify maintaining current prices.
5. Inversion principle
The inversion principle is a technique for solving problems that shifts focus to thinking about potential obstacles. Instead of trying to answer the question, “How can I succeed?” you’d ask, “What could lead to failure?” By identifying possible pitfalls in advance, you can create strategies to prevent or mitigate them. Navigating these challenges increases your likelihood of succeeding.
6. Law of diminishing returns
The law of diminishing returns is an economic principle that explains how, after a critical point, the additional output or benefit from each extra unit of input begins to decrease.
For instance, your startup might initially see productivity rise with more hires. But eventually, coordination challenges, training demands, and overlapping roles might reduce the value of each new employee. Recognizing the law of diminishing returns can help businesses balance growth with effective collaboration and resource allocation.
7. Occam’s razor
A mental model championed by the medieval thinker William of Ockham, Occam’s razor suggests that the simplest explanation or solution is often the best.
For example, if you see high cart abandonment rates, the obvious solution may be to offer shipping discounts rather than launching entirely new products. Looking at your business problems in such a way can help you tackle and test the easiest solutions first. If those solutions work, they’ve spared you from taking a more complicated approach.
8. Opportunity cost
In a world with limited resources, opportunity cost is the value of the next best alternative you sacrifice when you make a decision. It reflects what’s passed over in favor of a particular action, decision, or investment.
For example, using business profits for employee raises might mean forgoing a marketing campaign or inventory expansion. Similarly, asking employees to attend a lengthy meeting takes them away from their essential tasks. By recognizing opportunity cost advantages and downsides, you can make more strategic decisions and allocate resources appropriately.
9. Supply and demand
Supply and demand is a fundamental economic principle that determines the price and availability of goods. Supply represents the quantity producers are willing to sell, while demand refers to how much consumers are willing to buy. In a competitive marketplace, high demand and limited supply drive prices up, while excess supply lowers prices.
Ideally, supply and demand balance at an equilibrium, where the quantity supplied equals the quantity demanded, setting a price acceptable to producers and consumers.
10. Survivorship bias
Survivorship bias is a common logical error, where people tend to remember and draw inspiration from success stories while overlooking failures that offer critical lessons. It’s human nature to focus on positive examples, but ignoring the full picture can lead to overly optimistic decision-making.
For example, you might try to emulate your favorite celebrity by launching a beauty business, not realizing that hundreds of other aspiring business owners have not been as successful. Rather than focusing only on the positive stories, spend some time learning about when things go wrong and make a plan to overcome those obstacles.
Mental models FAQ
Do mental models really work?
Yes, mental models can help you better understand how the real world works by distilling down big ideas into simpler frameworks, benefiting your decision-making and problem-solving processes.
What is an example of a mental model in daily life?
You could apply the mental model of opportunity cost to your daily life. This refers to the value of what you give up when choosing one option over another. For instance, if you decide to spend your evening working instead of going out with friends, the opportunity cost is the enjoyment and connection you would have gained from socializing.
How do mental models relate to business?
Mental models are an important tool for business leaders to simplify complex challenges and make informed decisions.
