Path Dependency

Updated on January 31, 2024
Article bySusmita Pathak
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Path Dependency?

Path dependency in economics refers to the tendency to rely on past practices, decisions, and actions for the outcome rather than current conditions. Thus, those who repeat the same strategies will almost certainly get the same results. As a result, it can greatly impact economic or market development.

Path Dependency

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The path dependency theory can save time by providing a traditional path for conventional findings, even if better options are available. However, it is not recommended to depend on historical preferences if growth is the ultimate goal. The resistance or inability to change is usually due to cost considerations or hesitant or ill-informed judgments.

Key Takeaways

  • In economics, path dependency is the tendency to base outcomes on prior habits, decisions, and actions rather than current circumstances, even when better options are available.
  • Individuals or entities’ opposition to change is frequently due to financial considerations or hesitant or misinformed assessments. It can have a significant impact on economic or market development.
  • If the ultimate goal is growth, relying on this approach is not advisable. By reducing historical choices, anyone can achieve their objectives faster and more efficiently.
  • The concept applies to various fields, including politics, business, employment, trading, and social issues.

Understanding Path Dependency Theory

Path dependency theory in EconomicsEconomicsEconomics is an area of social science that studies the production, distribution, and consumption of limited resources within a society.read more refers to one of the best approaches to follow when there is less time to achieve a goal. Besides time being a factor, it tends to be more cost-effective, less complicated, and risky. The concept finds relevance in different scenarios, including scientific, political, financial, etc.

Path Dependency Factors

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It is the historical approach, the result of which is likely to be the same given the nature of the problem is similar. However, sticking to a traditional path is not always the best plan because it limits decision-making and slows growth.

This approach is preferred by those resistant to change. People usually depend on the existing answers to political, social, or business problems rather than finding new ways to address them. In a nutshell, they use prior decisions to arrive at a current conclusion.

Path Dependency Features

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With that, entities prefer to use prior behaviors to address a problem or increase production, ignoring superior alternatives. Therefore, each individual or entity should be flexible to change rather than sticking to the established actions, strategies, policies, practices, and approaches to achieve growth. They can achieve their goals faster and more efficiently by avoiding path dependency.

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Path Dependency In Politics

Politicians prefer to use the historical-institutionalist approach because of their incapacity to learn from the past and their predisposition to make prudent decisions. As a result of this dependence, the political structure and strategies do not advance as regularly as they should. Instead, the political system continues to function according to pre-existing rules and patterns.

The policymakers are seen working as per the same historical parameters and assumptions. Consequently, they reach diverse conclusions and make final judgments based on the same old variables, which may or may not be relevant in current political and economic conditions. They are unwilling to use technical measures because of this, regardless of how effective and superior those technologies would be in the current political setup.

Path Dependency In Business

Businesses that stick to tried-and-true tactics risk losing market shareMarket ShareMarket share determines the company's contribution in percentage to the total revenue generated within an industry or market in a certain period. It depicts the company's market position when compared to that of its competitors.read more to competitors who use creative approaches to attract clients. Their opponents leave them behind in the competition due to their inability to invest in forward-looking inventions.

Path Dependency In Stock Trading

In trading, traders stick to historical strategies even though they may not be the best option. However, most of them stick to the same method and take the same stance in every trade they make. It is how traders can tell if they are on the right track.

For example, if Johanna’s stock, which she bought at $100, is currently trading at $250, she should sell it right away to profit. However, if she resists this change and maintains her position, it would reveal her path-dependent behavior.

Example

Let us consider the following path dependency policy example for a better conceptual understanding:

A website designing company received an order for designing a unique website for a renowned company. The designer at the firm was well-qualified and had excellent skills to create the most attractive and original website design. But instead of working on the new design, the designer chose an existing template and decided to use it for the client.

As a result, the client was displeased and never sought their services again. The designer’s approach resulted in losing such a significant client. Despite having exceptional design skills, the designer resisted change, causing the company’s market reputation to suffer.

Frequently Asked Questions (FAQs)

What is path dependency?

Path dependency is a term used in economics to describe the tendency to base outcomes on previous habits, decisions, and actions rather than present circumstances, even when better alternatives are available. It is a more cost-effective, less difficult, and hazardous historical approach, the outcome of which is likely to be the same because the problem is similar.

Why is path dependency not always a great idea?

Those who are averse to change prefer path dependency. Sticking to a traditional path, on the other hand, is not always the ideal strategy because it restricts decision-making and inhibits growth. Therefore, to accomplish progress, each individual or entity should be flexible to change rather than clinging to the established activities, strategies, policies, practices, and approaches.

What is path dependency in stock trading?

In trading, path dependency is a practice that traders follow even though it may not be a good idea. Most traders stick to the same strategy and take the same position in every trade they make. It is how traders can tell if they are on the right track.

This has been a guide to Path Dependency and its meaning. Here we discuss how path dependency works in politics, business, and stock trading, along with an example. You can learn more from the following articles – 

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