Economics

Economics is a huge subject of immense importance. In the real world, it touches on absolutely everything that people do. Daily it occupies some of the finest minds on the planet, and yet still the mechanisms by which it functions aren’t completely understood. Even top economists can’t agree on everything.

Is it any wonder that it scares the willies out of virtual world designers?

As part of their trade, the designers of virtual worlds must accumulate a wide range of knowledge covering many specialist subjects; some of these they’d perhaps rather avoid, but none of them are truly avoidable. Economics is one such specialist subject. Unless it’s your own specialist subject, you’re in bother.

My advice in such circumstances is to visit your local university. Head for the bookstore and buy whatever book entry-level students are buying. This applies whether you want to know about economics, psychology, artificial intelligence, sociology, anthropology, astronomy, whatever ¹. Read the book you buy. If half of it or more makes sense, you probably have enough of a grounding to be able to apply your newly acquired knowledge to virtual world design. Complex though they may be, virtual worlds are nowhere near as complex as the real one; you may only have the gist of the subject, but when you’re working with something that’s only the gist of reality, well, that’s usually sufficient.

If you don’t understand even half of the book, hire a specialist. No sense in burning out your brain.

So, what, fundamentally, is economics about?

It’s about resource allocation. Resources are anything that people need or want for any purpose—land, food, labor, sports cars…. When resources are scarce (as they usually are), they can’t be allocated to satisfy every need or want, therefore some system of resource allocation must pertain. This system is the economy.

Some economies are more efficient than others. In a barter economy, I might raise chickens and buy the things I need using eggs. Other egg farmers could do the same. If two of us wanted to buy the miller’s last sack of grain, the one of us who was prepared to offer the most eggs would probably get it. If we both wanted the same Stradivarius violin, however, it would be more problematical: We might not have enough eggs, the seller might not have a use for that many eggs, and we could be up against someone else who wanted to pay in shoes. It’s likely that none of us will get the Stradivarius, even though we all want to buy it and the owner wants to sell it.

Most societies use currency to make transactions more efficient. I can convert my eggs into coins. I can save these up to buy a Stradivarius ², and the person from whom I buy it can use the coins to buy other things. Currency facilitates transactions.

The example with the eggs, although it uses a barter system, follows the principles of a free market economy. Prices fluctuate depending on supply and demand. If the miller had many sacks of grain, I could have got a sack at a lower price; if I had many spare eggs, I could have afforded to pay more eggs for a sack.

For virtual worlds, a free market is not the only option available. There are basically four types of economy you can have:

• None

• Fixed prices

• Free market

• Faddish

Having no economy is fine for worlds with very low persistence. It isn’t that there’s no economy at all, of course, just that there’s no formal economy. If you can’t save objects across sessions, for example, there’s very little reason to buy things; informal bartering is enough. It’s possible that there could be a service market (“I’ll train up your strength if you give me 400 units of currency, which I can save up to spend on improving my fishing skills”) but even this is amenable to simple barter.

Heavy role-playing-style textual worlds often have no formal economy (although some older custom codebases ³ omitted it, too). In these, it’s common for people to give things away that they don’t need, thereby encouraging a community-strengthening favor reciprocation system. The more persistent a virtual world is, though, the greater the need for a formal economy; otherwise, players wanting to exchange goods and services get very frustrated if their favors are not returned.

The fixed-price approach also works in low-persistence virtual worlds. If you can’t take your cash with you when you quit, fixed-priced objects retain their worth. If you can take some money, but only up to some moderate amount, that also can work. If you can keep arbitrarily large amounts of money, fixed pricing eventually equates to “free.” I’ll explain why shortly.

Prices in a free market change to reflect how much people are willing to pay and how much people are willing to be paid for particular goods or services. This is the approach used by most virtual worlds. It ought to work—it does in the real world—but there are a few problems that virtual worlds have which the real one doesn’t. Again, I’ll come to these shortly (after I’m done summarizing economy types).

The final common type of economy is whatever fad idea enthuses the designers enough that they decide to use it. Although the designers will thus be 100% committed to it, prospective players will generally be 100% the opposite. It may well work in practice as well as in theory, but the chances are it will do neither.

Most virtual worlds aim for a free market economy. There has yet to be a successful large-scale implementation of this, however. There are two reasons for this: Designers don’t make the economy as free as they think they’re making it; players beat it to a bloody pulp.

Let’s see how these situations develop.

Wealth enters the system: The main sources of this are monster drops, quest rewards, farming/mining, and newbies’ grubstakes. Characters accumulate wealth. By their efforts, they may create more wealth by adding value to items or by performing services. Wealth leaves the system: In a closed economy, what leaves goes into some simulation (for example, of the activity of unseen NPCs) to return in some form later. In an open system, what exits the system has no effect on what enters.

What happens when, because of players’ industry, wealth appears at a faster rate than it disappears?

In a closed system, the rate at which recycled wealth enters falls to compensate. There are fewer monsters and quests, or the rewards for success are lower. Players find they are receiving less money, so are more inclined to keep what they have ready for when they really need it; this means that the amount of wealth leaving the system falls again, leading to a fall in the amount entering. It’s a vicious circle, which guides the economy to a grinding halt. All it takes is for more people to hang onto their wealth than the designers had allowed for, and it’s guaranteed to happen. Given that organized griefers will figure this out and deliberately save money just to watch the whole edifice tumble, closed economies can always expect to dry up eventually ⁴.

Most virtual world economies are open. If more wealth comes in than goes out, then players accumulate wealth and can buy more things; if less wealth comes in than goes out, they go broke and can buy fewer things. This doesn’t matter in a truly free market economy, because prices can rise or fall to match income—even inflationary income. If today the average wealth of a character is 500 UOC and a new helmet costs 10 UOC, then in six months when the average wealth of a character is 5,000 UOC the price of a new helmet will be 100 UOC (if supply and demand remain constant). Thus, although absolute prices may change, relative prices only change when supply or demand changes.

In a fixed-price economy, this doesn’t happen. A 10 UOC helmet costs 10 UOC whether people have nothing in the bank or millions. It’s normally the latter; this means that after a while helmets are basically free—great news if you want a helmet, but terrible news if you’re a player whose character manufactures helmets. In any system with fixed pricing, inflation hurts everyone who crafts goods for which fixed prices pertain. It doesn’t matter if you can raise or lower your own prices: If NPC vendors buy and sell at fixed prices, you’re screwed.

The obvious solution to this is to have variable prices—that is, a fully free market. The problem is that unless all prices are variable, this doesn’t work. One consequence of this is that quest rewards and mobile drops should be variable, too. Who’d want to risk life and limb for 20,000 UOC if it wasn’t enough to buy an arrow? Yet how do designers make these price rises occur rationally in such a way that unscrupulous players ⁵ can’t screw over the system?

Actually, it’s surprisingly doable. The trick is to give goods rather than cash as rewards. Goods get their value from the free market; therefore their value varies in keeping with supply and demand. If you get a wolf pelt for killing a wolf, then the sum total of the wealth of the virtual world increased to the tune of one wolf pelt. The amount you can sell this for depends on the demand for wolf pelts at the time. If demand is low, you get a smaller return than if demand is high, therefore you go off and kill something else instead of wolves. This will lead to a drop in the supply of wolf pelts until there’s a shortage of them, whereupon prices will rise and you might think about killing wolves again. It all works very neatly.

Unfortunately, there are some consequences of the free market economy that require players and designers to accept some as-yet unpalatable truths.

Designers first. A free market economy operates using what Adam Smith famously called an “invisible hand” ⁶. Individuals work to promote their own self-interests, but in so doing promote the interests of society as a whole (generally unintentionally). Farmers sell us food because it’s in their interest to do so, not because we’d die if they didn’t. If all players act in their own best self-interest, the free market economy will flourish.

Unfortunately, in virtual worlds players’ best self-interest may be to make your economy collapse—and that’s not even the worst of it.

In the real economy, you have to participate because there’s nowhere else to go. Everyone can’t be rich; some people have to be poor. In virtual worlds, you do have somewhere else to go. If you’re poor, you can emigrate to some other world where you can be rich. In the real world, if no one buys the helmets of which you are so proud, you have to make something else instead; in the virtual world, you quit and go where helmet-making is valued. Helmets, potions, laser rifles—it applies to all crafted items.

Also, the free market model says that if a bunch of players want and can afford quality swords and there’s no one making them, the demand will prompt someone to get into the quality sword business. Unfortunately, that reasoning only applies within the context of the virtual world. The demand also can be satisfied by frustrated fighters decamping to some other virtual world where there is no sword shortage. No matter how much a designer might want it, his virtual world’s economy can never be truly closed because players are a part of it and players can come and go. The free market does work here—supply, demand, and prices do achieve equilibrium—but it works in a way that hurts your real-world profits.

It may be that a free market has unpleasant consequences on the virtual world itself, too. Take the example of bakery wars: A big guild with deep pockets sets up a bakery in a town that already has a bakery. The established shop has a loyal customer base, a long-standing reputation, and it makes tasty bread. The guild shop starts to give away free bread. People go to the guild for their free bread.

What does the local bakery do? It can give away bread for free too, but it still has to pay for the raw materials and it therefore takes a loss on every loaf (so does the guild, of course, but the guild is rich and can afford the loss). The bakery can continue to charge a fair price for its bread, but people won’t buy it because they can get something fairly similar for nothing from the guild. Eventually, the original shop is going to have to face facts and shut down. The guild will then hike the price of its own bread sky high so that it not only covers its losses but it becomes even richer. Do you, as a designer, allow such monopolistic bullying ⁷? It’ll cost you at least the local baker and perhaps some of the people who used to buy their bread there. If you thought about it in advance you can devise ways to stop this sort of thing from happening, but what about the ways for players to turn over your economy that you haven’t thought of? What checks and balances do you have in place to defend against unforeseen attacks?

Another example: pelt hoarding. Suppose a guild seals off the forest where the snow wolves live. No one goes in or out of the forest unless the guild guards get out of the way. If there’s a constant demand for snow wolf pelts (they’re used for making frost storm spells or something), then the price of snow wolf pelts will rise. Ordinarily, it may be that the forest spawns 20 snow wolves a day and the pelts fetch 50 UOC each. Now, it’s still spawning 20 a day but if the guild only kills two of them, then each pelt may fetch 1000 UOC. That means they double their profits. This is how cartels operate: By restricting supply, demand is artificially inflated and prices are kept artificially high. Do you have your world react to this, for example by spawning snow wolves in more places? If not, the players who need the pelts will wail about how your crock of an economy allows this kind of abuse to occur. But if so, the cartel will flood the market with snow wolf pelts until your spawning stops, then repeat—all the while complaining bitterly about your interference.

This brings us to the second group of people who have problems with a free market economy: the players.

Players will produce spreadsheets covering your economy. They will then gouge it. They will expect to gouge it, regard it as perfectly natural behavior, and be outraged if you make any attempt stop them. Everyone else, on the other hand, they regard as having no right to exploit the economy in any way remotely detrimental to their own well-being. This is true in the real world, of course, but you can’t quit the real world; you can quit virtual worlds.

In a free market economy, the activities that people undertake will sometimes be rewarded poorly. This acts as an incentive for those people to do other things that are better rewarded instead. Unfortunately, for a player of your virtual world, “better rewarded” might mean playing some other virtual world rather than yours.

Suppose you, as a player, like making clothes. It’s a big creative thing with you—you enjoy seeing characters walking around wearing your designs. Your entire aim when selecting a virtual world is to have your character be a tailor. So, you sign up to a world that lets you be a tailor, and start to churn out jackets and skirts and coats with which you’re immensely pleased. What happens if there are so many other tailors around that nobody wants to buy your clothes, no matter how much you advertise them?

In the real world, you would lose money to the extent that eventually you’d have to face facts and stop making clothes. In the virtual world, you would scream and scream and scream until the world was “fixed” so that there were always NPCs willing to buy your garments. If it wasn’t “fixed,” you’d eventually leave in disgust at its betrayal. Again, the virtual world’s free market economy is working, but the real world’s free market economy is also working; of course, the real world always wins.

Players want an honest day’s pay for an honest day’s work. If you don’t reward them, they feel cheated. If you set up yourself as a snow wolf hunter and make 50 UOC per pelt profit, you’re happy. If other people find that killing snow wolves is profitable, they’ll join in. With the resulting increase in supply, you’ll find you can’t sell your snow wolf pelts unless you drop the price. Now you’re making only 40 UOC per pelt ⁸. What do you do? Either you accept the realities of the free market or you dash off an email to the community service team screeching, “Your STOOPID game NERFED snow wolves!!!” ⁹.

Players like it when the free market works in their favor; they don’t like it if it doesn’t. This may be a problem that, in time, the maturity of players cures. Then again, if enough precedents for pandering to players are set then it may never get the chance to be tested. Players will complain—and get a hearing—if they do things that are blatantly stupid.

Player: “You killed my chickens!”

Community manager: “You built your chicken farm in a forest full of wolves. Didn’t you expect maybe they’d eat your chickens?” Player: “Are you hearing me? YOU KILLED MY CHICKENS!”

Telling players that the miserable time they’re having is all their own fault will not endear you to them. If they spend four hours hunting wolves when the price of wolf pelts is rock bottom, they don’t like being told to hunt something else instead. If they’re told that hunting itself is an over-subscribed activity (having designed their character to be a hunter), they will be absolutely livid. Players will spend a lot of time being miserable if the reward is high enough. They’ll mindlessly click on the same “mining” icon for three hours, hating every moment of it ¹⁰, if the result is that they find the diamond they need to give them an arrow of dragon-slaying. It’s when they make themselves miserable for no reward that the problems come. They want an honest day’s pay for an honest day’s work; they’ve done the honest day’s work, so now they want the honest day’s pay. It’s immaterial to them that what they’ve done is as useful as counting buttons.

It’s because players are frequently unwilling to accept this consequence of a free market economy that virtual worlds will guarantee prices for crafted objects. This assures a market, so players stop complaining, but then there’s no incentive for them to change to making something people really want. Besides, players have other requirements, too: Someone who makes clothes that no one buys may be temporarily pacified by being able to sell them to NPCs, but unless NPCs actually wear those clothes they’re still going to feel unfulfilled. Even then, NPCs aren’t PCs. Surely, PCs would buy your clothes if only their existing clothes wore out quicker? So it’s complain-to-live-team time yet again.

Note that designers don’t have to guarantee fixed prices, just decent prices. It’s perfectly within the power of the live team to change prices manually or to force a change by (again, manually) altering supply and demand—creating and destroying virtual goods is free for them, after all. In the real world, the social costs involved in doing this are too high for it to be successful; as economist Edward Castronova has pointed out ¹¹, however, these costs are absent from virtual worlds and therefore price-fixing could be considered a viable strategy in such an environment. However, as I’ve just illustrated, there would remain other undesirable effects to do with concepts of fulfillment and self-worth. So although live teams could indeed attempt to control prices, they’d have to know exactly what they were doing to succeed (and be ready for the inevitable accusations of bias and favoritism that would follow).

Fixed prices aren’t in keeping with a free market, and neither is fixed income. If all newbies get a grubstake of so many UOC, the purchasing power of that grubstake depends on prices. It’s better to give them a range of kit, but even that can lead to perceived unfairness if the exchange value of what today’s newbie gets is more (or less) than it was two months ago. It’s more palatable than giving inflation-adjusted grubstakes, though.

Similarly, if monsters drop a (relatively) fixed amount of coin when they die, what it will buy depends on current prices. Again, it’s better if you make them drop some resource that can be traded instead of raw money, even if the money is inflation-adjusted—players will moan if “last week I only got 600 UOC but this week my friend got 650 UOC, so you owe me 50 UOC.” You can still get a form of inflation with this, though: A mobile dropping a +1 sword is dropping nothing if everyone already has a +1 (or greater) sword.

Fixed prices and incomes are bad for an economy, as eventually either everyone can afford everything (inflationary world) or no one can afford anything (deflationary world). Fascinatingly, this same argument can be used to justify assigning constant experience point values to mobiles: The more experience points you have, the less the value of an “easy” mobile is to you. Therefore you have to go for the tougher mobiles that give higher returns (leaving the easier mobiles for relative newbies). A consequence of this “level inflation” is that eventually no mobiles are worth enough. Without sufficient sinks (that is, ways to lose experience points), new content must be added somehow, either by the live team or designed-in as an elder game.

Of early virtual world economies on a massive scale, Ultima Online’s was the best. It almost worked. The economy and ecology were interlinked and interdependent. It began as a closed system, but it soon became apparent that the sum total of the world’s wealth wasn’t large enough to go around. It switched to a faucet/drain economy, which held up for a long time despite having some fixed prices (for crafters) and periods of inflation due to bugs. What finally broke it was the lack of sinks: People didn’t have enough to spend their money on, so it simply accumulated.

Following on from UO’ s complex economy, there was a backlash. EverQuest and Asheron’s Call both had much simpler economies. Both of these suffered from inflation, although in EQ’s case the vast numbers of newbies entering the world managed to soak up the excess to some extent and eventually the economy became relatively stable. AC rapidly achieved hyperinflation (it wasn’t helped by some money-duping ¹² bugs that effectively gave players their own mints) and its economy never really recovered. Unsurprisingly, most of the EQ–inspired graphical worlds went for the EQ approach rather than the UO one, although Star Wars Galaxies sees the pendulum swinging back to a system that doesn’t require a newbie hose to sustain it (ironically, because SWG does have a newbie hose).

The interesting thing to note about formal economies is that when they do break, an informal economy will normally emerge to replace them. AC’s informal economy, based around gem shards (needed to make kick-ass armor), certain keys (giving access to spell scrolls and other kick-ass armor), and writs (required to lease a house), became highly robust and stable; the formal economy was only used for interactions with NPCs. It’s to the designers of AC’s credit that although the economy they originally put together fell apart, their virtual world was sufficiently deep that the informal economy that replaced it became something of an exemplar.