Monday, September 14, 2009
The inefficient market hypothesis
Getting rich in a game like World of Warcraft or getting rich in the real world are two very different things. In the real world buying something and then reselling it for twice the money is incredibly hard, for the simple reason that there are quite a lot of people jumping on every opportunity to make a profit, and if that profit can be made by simple buying and selling with little barrier to entry, then there is a lot of competition, driving the profits down. There is an economic theory, the efficient market hypothesis, which basically says that in financial markets there are enough people buying and selling everything that prices reflect all known information about a financial product. Thus traders are forced to use increasingly complex methods, like milli-second trades, to make tiny profits, leveraged with lots of debt, to end up with annual profits of a few percent.
In World of Warcraft you can make thousands of percents of profit per year if you are inclined to do so. It is completely feasible to start the year with 1 gold piece, and end the year at the gold cap of 214,748 gold, only by trading and crafting, without farming anything. To an economist it is clear that this implies that the market of World of Warcraft is inefficient. Players constantly sell goods for less than market value, and constantly buy goods for more than market value. Thus both simple buying and selling, and the only slightly more complicated way of buying, transforming, and selling, can result in huge profits every week.
If you check out the various WoW economy blogs, you'll always find the same set of tips: Transforming ores into gems, transforming herbs into inks and glyphs. People who reached the gold cap nearly all used inscription to get there, and report how they made hundreds of percents of profit every week by posting 1,000 to 2,000 glyphs at any given time. That is a great example of the inefficient market hypothesis: It is obvious that having over 1,000 glyphs on the AH all the time only works against minimal competition. Imagine just 10 players on the same server and side all trying to pull this off at the same time, and the market would be completely flooded with glyphs way beyond demand, with profits crumbling in consequence.
So why, out of thousands of players on each server and side, is there only so few trying to get rich quick? Why are markets so inefficient? The answer is simply that money doesn't have any intrinsic value, but that its value is defined by what you can buy with it. In the real world there is no money cap, and even if you have billions there is always something you could buy with it, whether that is a company or the cure to malaria. In World of Warcraft it is quite difficult to imagine what to do with 214,748 gold. A part of the economy is "price controlled", that is run by NPCs with fixed prices, only changed occasionally with patches. The other part of the economy is operating at a price level which is basically determined by what a level 80 character can make in gold without farming, buying, or selling, just by regular playing, looting, and daily quest rewards. Thus even a stack of copper bars on most servers is worth several gold now. And the level 5 character who can gather copper ore and transform it into bars and sell those thus is able to earn several gold pieces per hour, making both the fixed costs of lets say training or flying, and the fixed monetary rewards from loot and quests at that level comparatively tiny and irrelevant. If somebody is just playing normally, selling the boe loot he finds in the process on the AH, and maybe doing a bit of herb or ore gathering just for fun, he'll have enough money to pay for everything he needs.
Thus compared to the effort of crafting thousands of glyphs, needing several dedicated alts just to handle the inventory, the huge profits of inscriptions are simply not interesting to the average player. Why spend so much time and effort to make money you can't spend, because you already have everything you need? In fact most people have *more* gold than they need, thus they don't mind overpaying for those glyphs somebody else made. And if they ever plan to buy something more expensive, like an epic flying mount for 5,000 gold, and don't have the money immediately, they still prefer to earn that gold in ways which more closely resemble their regular play patterns. This weekend, just for the fun of exploring, I spent one hour mining, and ended up with one stack of titanium ore, and five stacks of saronite ore, about 500 gold after prospecting. I make 100 gold a day in the 10 seconds it takes me to log on my alchemist and transmute a rare gem into an epic one. And when I do daily quests for the Argent Tournament, I get over 13 gold per quest as extra to the token or reputation I was actually after. If a player who just plays whatever he fancies in a casual way already makes over 1,000 gold a week, it is no wonder that you can easily sell a glyph for 20 gold, although the materials only cost you 2 gold. Players spend their gold in inefficient ways on the auction house, because there is no need to be frugal. Using these market inefficiencies to make a virtual fortune is easy enough, as long as there aren't too many people around with the same idea.