Warcraft is not the World: Economic Implications

Economics is a funny thing. Warcraft economics is even funnier. Fair warning: I don't have a Ph.D in Economics, so some of what I say could pretty easily be wrong. Then again, it could be right too.

I've got a couple of things to say about Warcraft economics, going to spread this out over the week or so. I'm sure, if you read gevlon, a lot of this sounds familiar (heck, I might even have subconsciously cribbed it from him). Anyway, today we're going to talk about prices.

"No price is crazy if people pay for it."

I just saw that quote on the Professions forum, in a thread about jewelcrafting. There are other, similar sentiments around- "what the market will bear", and so on. Generally speaking, these phrases are bandied about when discussing whether or not a particular price for an item is appropriate. Should glyphs default to 40g or 4g? Should epic gems cost 250g or 100g apiece?

What's the proper price for an item that you have?

Warcraft is a funny thing, because there is a quantifiable price floor for any sellable good: vendor price. A glyph, for example, sells to the vendor for 1s. That's the only real line you can draw about what counts as a sane price: if you sell glyphs at the auction house for less than 1.1s per item, after losing the AH cut in sales you would have made more money just vendoring the item. Any difference between vendor price and actual sale price is profit.

In a perfect World of Warcraft, vendor prices would make sense, and all auction prices would eventually trend down to the vendor prices as competition goes up.

Glyphs in particular are a really annoying commodity that represent how broken the actual World of Warcraft is. A typical glyph requires some kind of parchment, the good ones take Resilient Parchment. Resilient parchment costs 50s from the vendor, and vendors for 12s50c. There is no other way to get resilient parchment. Ink of the Sea is created by milling herbs, but has a 5s vendor price itself. That means, the first thing a glypher does is spend 55s to create an item that has only 1s "real" value. At the very least, in a more-perfect WoW, glyphs should vendor for 55s. It would definitely be nice if every crafted item had a vendor price that was the sum of the vendor prices of the item's ingredients.

I'll relent on that for the time being, to get back to my main point: When you ask yourself, "what is this thing worth?" the only hard-and-fast answer is the vendor price, period. The second answer to that question is: how much did the item cost you to make?

While the vendor price of an item is an external reality and unlikely to vary from player to player (save faction discounts), the actual material cost for an item varies quite a bit. The herb market drives glyph prices- if I can get a stack of good herbs for 15g, I can charge less per glyph and still make a profit than the guy who is paying 30g per stack.

Don't get confused at this point and say, "well, I farm my herbs, so I pay 0g per stack". That's a fallacy: don't ignore opportunity costs. If you farm your herbs, figure out how much you COULD have sold them for if you put them up on the AH. That's how much your herbs cost, because if your glyph rates fall below that level, you'd be better off selling the herbs straight, rather than the glyphs. More on opportunity costs in a later post.

So, when somebody tells me that I'm pricing my glyphs too low, I know that they're coming at the problem from the wrong angle. All my glyphs are priced such that (a) they represent a real profit over vendor price (as well as the vendor price of the constituent parts, which if they didn't, I'd just vendor the materials), and (b) they represent a profit over what I actually paid for the materials. This brings us right back to the "what the market will bear" fallacy, which is flawed in two directions: elasticity and competition.

Elasticity refers to the change in demand as price varies. If you charge 10000g per glyph, a lot of people will say, "you know what? I think I'll just run un-glyphed and accept the fact that I'll have 3% less DPS." If you charge 1s per glyph, nobody will say that. In between is in between. Consider the price for Battered Hilts. If you're leveling an alt (or just getting toward ICC for the first time on your main), there's probably a lot of utility to be had in getting a Battered Hilt. Everybody wants one. But only some people think it's actually worth buying. If you could sell battered hilts at 2,500g per instead of the 15,000g that they go for on my server, you'd make a bundle- lots and lots of people would be buying them. So, 'what the market will bear', or 'no price is silly if people will pay it', is an overly-simple line of reasoning. Yeah, the market bears 20,000g for a Battered Hilt, but there's only one sale a week, if that. You have to account for demand elasticity.

Competition doesn't need as much explanation, hopefully. The important thing about it is that your competitors may have a different target price point than you, because they have a different idea about where in the price elasticity of demand curve they're aiming. Consider the difference between the prices of a corner bookstore and Borders. Borders has cheaper books, pretty much across the spectrum, of the new releases at least. They sell new hardcovers at 20-40% off cover price. The corner bookstore might say, "hey, you're undercutting the price that's written on the book, you poopypants!" Borders would respond, "well, yeah, we're making less profit per sale, but we're making so many more sales that it all works out in the end". Think WalMart here.

The WalMart model only works a little bit here- they keep their prices artificially low because they don't pay nearly as much in raw materials prices as other retailers. But the trade-off between per-unit profit and volume sales is a clear one that should make sense.

When a new competitor comes into the market with a different idea of what an item should cost, they're not being dumb. The only price written on any item is the vendor price, and any sale price other than that is negotiable and not likely to last.

At the end of the day, that's what economics is all about: trying to understand how people make up numbers to associate real value to imaginary benefits. More to come.