A Deal is a Deal...

In my last blog, I said that I might be tempted into posting something about economics, rather than graphics. Well, I figure it's worth the possible embarassment of getting something wrong in order to give you guys something different to mull over. I'd also like to point out that since my last blog, the dev blogs section of this website no longer requires you to log in, which is nice.

It's worth noting that I'll probably generally be discussing macroeconomics which is the study of economies as a whole, rather than the individual entities within them. If you'd like to learn more about it, the best book I've found so far is "Macroeconomics" by Paul Krugman and Robin Wells (if you happen to know of any other good books, I'm very interested, and I'd ask that you tell me about them in the forum thread about this blog).

I'm going to devote this blog to inflation, because almost any discussion of economics in MMOs comes round to this subject sooner rather than later. Let's start simple and build up a foundation for discussion, because I'm in the enviable position of having you as a captive audience.

As I've pointed out in my last blog, I have no formal education in Economics, so I'm expecting errors all over the place, and will be very happy if you point them out to me. If there are any serious economists (with qualifications) out there who would like to work with us, I suggest that you drop us an email at scc [AT] eve-online.com

What is Inflation?

First, we have something called the Aggregate Price Level, which we define as the overall price level of all final goods and services in the economy (final goods and services are those that are sold to consumers, rather than used to produce new things). We say that when this price level rises, the economy is experiencing inflation, and when it falls, the economy is experiencing deflation.

What does this mean though? We haven't really properly defined this aggregate price level yet... At a basic level, we're saying that inflation is when you're generally paying more for the same products, or that the real value of your currency is falling. You can see how this could be really bad for an MMO, especially if your sources of income in it aren't matched to inflation - you could be killing an NPC for cash (gold / isk bounty) and the result of your work would buy you less than it did.

Aha, a basket case!

The way that we generally measure the Aggregate Price Level is by creating an indicator of it called a Market Basket, which is a number of products and services that are thought to represent the consumption of a normal consumer over a period of time (I might assume that 5 cups or tea or coffee should make up a typically market basket for a day, for example).

Well, that sounds simple enough... We could construct our Market Basket almost any way we want, and assume, for the fun of it, that our basket involves a Small Armor Repairer I, 4 Medium Pulse Laser I's, 4 Radio S and a Punisher (no, that's not an uber fitting). So for the sake of the mental exercise, lets do that.

NB: The graph has a resolution of 1 day, so a few abnormal transactions can cause a peak.

So this is cool... we're getting somewhere (even if it is on a particularly dodgy Market Basket). If we were to assume that this market basket was a good one, we could assume that the Aggregate Price Level followed the same trend - but clearly, this is a numerical cost value, and that doesn't really translate directly to something generalisable. This is where a Price Index comes in. The price index is the price at that time, divided by the price at a "base" time, multiplied by 100 (which puts it into percent).

If we took a date around launch to be the base, and measured that price as around 300,000 isk for our market basket, and looked at the price at the most recent time that I have data for (around 350,000 isk) then we'd say that this price index was at around 116.7, a growth of 16.7 points in almost 3 years, which I figure works out at about 5% per year. That's actually less than inflation in Iceland at the moment - 8%! [Just for interest, I did this with a Tempest + fitting too, and the change was closer to 9% over 3 years]

Wait a second...

You might have noticed that this isn't a particularly good Consumer Price Index - and you'd be right, I just picked some items out of a hat to make it. You might also notice another issue with it: There's no tech 2 items...

Hohum. The problem we're glancing off is one of innovation increasing the choices available in the market, and where an increase in the price of one thing might lead to consumers buying another instead (Substitute Goods). In fact, tech 2 items probably qualify as Luxury Goods - goods for which demand increases as income rises.

Wait, what about HAC prices? That's inflation, surely?

HAC prices have certainly been on the rise, but there's not so much to indicate that this is a feature of general inflation, and it's much more likely to be a shift in the Demand Curve. (uhoh. There's a whole economics textbook in talking about that...). To keep this relatively short, the number of people able to fly HACs has increased significantly, and yet the number that can be supplied by manufacturers has not - this would suggest that demand has increased, but supply has not.

How can I suggest that though? Well, the easiest way to see approximately how many people could fly a HAC is to take the total volume of HAC skillbooks sold up to that point.

So my suggestion is that the cost of HACs is closely related to this graph. Can we try and show that? Of course we can!

What you're looking at is the average cost of a Vagabond plotted against the number of people that can fly HACs (by our crude measure of skillbooks). In order to look at this properly, I'd have to draw you a lot of graphs to look at things like changes in input prices, changes in prices of substitute goods and changes in income (etc) - doing that in this blog would make it too long for sanity.

Hold on a sec, where do "isk sinks" come into this?

There's a theory called the Quantity Theory of Money that, in short, means that if you increase the amount of money in a system without increasing output, then you get inflation. The problem is, I've been studiously avoiding discusing the Gross Domestic Product of Eve this time, because it's a lot harder to measure. Let's accept it, and leave literature on Hyperinflation to the interested reader.

So, under the assumption that creating money too fast leads to a decrease in the value of money, how are MMO's at risk? We create new money all the time. When you kill an NPC and get paid a bounty by Concord, we just create that cash out of thin air. When you take out insurance, you pay some money initially, if you lose that ship, you get more money back, which (again) is just created on the spot.

Since this is a very important point that people seem to miss very frequently when this is discussed: trading money between two people doesn't (usually) increase the amount of money in circulation - this is usually the missaprehension involved with insurance in Eve. Watch carefully...

• Player A has 100 million ISK, Player B has a "Generic Battleship". Total ISK: 100 million

• Player A buys the "Generic Battleship" from Player B for 70 million. Total ISK: Still 100 million.

• Player A insures the ship for 30 million ISK, ISK dissapears into the void. Total ISK: Now only 70 million!

• Player A loses the ship within the insurance period, gets a payout of 100 million. Player A has 100 million, Player B has 70 million, Total ISK: 170 million! [ACK!]

Under normal conditions, the insurance company would be trying to make a profit from the people it insures, and so would be attempting to make sure that the insurance premiums paid to it would at least cover its payouts. In the case of Eve, this is not happening, because we wanted to make death hurt, but not as much as the total loss of the ship and everything in it. In a game where one of the major points of the game is to PvP, it's unlikely you'd be able to make any money off insurance without a ridiculously large insurance premium, and people would generally just avoid paying it unless they knew they were going out into danger and would work out better off. So in Eve, the insurance company runs at a loss, and we cover that loss by creating money (the same goes for Concord bounties and trade goods etc).

We call anything that introduces money into the economy an ISK Faucet and anything that takes it out again an ISK Sink. POS, for example, were designed to be a small ISK sink - they consume and destroy items that you have to pay NPCs to buy. An item is created, the ISK is destroyed, and then it's consumed while the tower is running. The last time I looked, I think POS were sinking nearly 3 billion ISK per day out of the economy in Eve, but this is actually a drop in the ocean in the overall economy of Eve.

I think I'll leave it there, before I end up writing a book in a dev blog, and I'll think about what I'll write about next time based on feedback from this.