What Economists Are Learning From Video Games

Economists are only interested in real money, right? For a new wave of economists from across the globe—dead wrong. Brad Plumer recently wrote in The Washington Post about what economists can learn from virtual economies in video games, which, strangely enough, work pretty much the same way as those in real life. From a major banking crisis causing chaos in Second Life to Eve Online creating a central bank run by real economists to regulate its economy, virtual markets have similar features to traditional markets and also require regulation and analysis. Plumer writes:

Inflation can be a headache for any central banker. But it takes a certain type of economist to know what to do when a belligerent spaceship fleet attacks an interstellar trading post, causing mineral prices to surge across the galaxy.

Eyjólfur Guðmundsson is just that economist. Working for the Icelandic company CCP Games, he oversees the virtual economy of the massively multiplayer video game Eve Online. Within this world, players build their own spaceships and traverse a galaxy of 7,500 star systems. They buy and sell raw materials, creating their own fluctuating markets. They speculate on commodities. They form trade coalitions and banks.

It’s a sprawling economy, with more than 400,000 players participating in its virtual market — more people, in fact, than live in Iceland. Inflation, deflation and even recessions can occur. Which is why, from his office in Reyjkjavik, Guðmundsson leads a team of eight analysts poring over reams of data to make sure everything in Eve Online is running smoothly. His job bears more than a passing resemblance to that of Ben Bernanke, who oversees the U.S. economy from the Federal Reserve.

“For all intents and purposes, this is an economy that has activity equal to a small country in real life,” Guðmundsson says. “There’s nothing ‘virtual’ about this world.” [1]

Guðmundsson’s challenges are surprisingly similar to those in real markets. He has had to work around groups of players who manipulate market prices of goods much as cartels like OPEC do in traditional markets.

Guðmundsson oversees an economy that can fluctuate wildly — he says it expanded 42 percent between February 2011 and February 2012, then contracted 15 percent by the summer. His team will periodically have to address imbalances in the money supply. For instance, they can curb inflation by introducing a new type of weapon, say, to absorb virtual currency — not unlike the way a central bank might sell bonds to shrink the money supply. (In theory, Eve Online’s currency has real-world value — the highest-level spaceships, the Titans, are worth the equivalent of $5,000 to $8,000.)

2009-2010 manufacturing data from Eve Online

2009-2010 inflation data from Eve Online

2009-2010 money supply data from Eve Online

Eve Online is just one of many MMORPGs with such a realistically volatile economy that it hires real-life economists to manage its virtual economy. Experience has shown that, just like regular market economies, virtual economies need substantial regulation and oversight in order to remain solvent.

A 2007 sign in Second Life’s BCX Bank said it was “not currently accepting deposits or paying interest.”

For example, before Second Life began intensively managing its virtual economy, an imposed ban on gambling triggered a “virtual bank run” in 2007, just as the United States’ economy was itself in a bank scare [2]. Users panicked and suddenly rushed to withdraw all of their “Linden dollars,” which are valued at about 269 to one U.S. dollar. Like unregulated banks in real life, Second Life banks advertised high rates of return on deposits but then often used them to invest in risky virtual casinos and other speculative ventures that suddenly went bust. In the 2007 crash, the virtual bank Ginko Financial alone cost Second Life users $750,000 in real U.S. dollars, since users have to purchase Linden dollars with real money.

But the relationship between economists and video game designers isn’t one-way. Just as video game designers have started hiring economists, many academic economists are beginning to use the virtual world to test out economic experiments that aren’t possible in real life. For example, Eve Online has full-reserve backed currency, the same policy called for in the United States by Texas Congressman Ron Paul and other libertarians. However, even though Eve Online’s banks must maintain 100% of deposits in reserve, there is still room for fraud. According to Plumer, the virtual bank EBank collapsed in 2009 when its founder seized the bank’s virtual assets and sold them for real cash.

These kinds of economic scenarios can easily be conducted online with outcomes and consumer choices that can be easily tracked. One economist who has jumped the academic boat describes video games as the next major avenue for economics:

“Economic theory has come to a dead end — the last real breakthroughs were in the 1960s,” says Yanis Varoufakis, a Greek economist recently hired by the video-game company Valve. “But that’s not because we stopped being clever. We came up against a hard barrier. The future is going to be in experimentation and simulation — and video game communities give us a chance to do all that.”

Plumer thus calls virtual economics “a libertarian experiment on a grand scale,” and suggests that we have a great deal to learn from analyzing markets that are less regulated than any in real life. For example, virtual economies have no minimum wage, so their recessions tend to be short-lived because labor bounces back quickly, unlike in regulated markets with sticky wages. Players can also organize in innovative ways such as corporations, cartels, and financial institutions that resemble ours but have more experimental regulation.

Traders on Eve Online track the price of virtual resources like technetium using tools from real markets

So what can we actually learn from virtual economies? Because virtual economies closely resemble real economies, they provide useful information about markets and consumers at low cost. Virtual economies can also be measured exactly, without the sampling error that makes measuring real markets expensive and inaccurate.

“To this day, we haven’t seen anything in these virtual environments that violates fundamental economic theories,” says Ted Castronova of Indiana University Bloomington, one of the first scholars to study virtual worlds. After all, the fact that prices rapidly adjust to supply and demand in Eve Online isn’t shocking. Economists have studied artificial currencies in other contexts, such as cigarette trading in prisons.

Some economists, however, are starting to observe intriguing phenomena. A 2010 study by Cornell’s Bloomfield looked at an unregulated stock exchange in Second Life, called SLCapex, which raised $145,000 from investors. He found that the market tended to favor large investors over small investors. And, he realized, existing economic theories could not explain why issuers continued to raise so much money in such a setting.

Another scholar who studies virtual worlds, Magnus Thor Torfason of Harvard Business School, says it’s surprising that there’s not more cheating in virtual worlds — as when the head of EBank simply absconded with the bank’s funds. That, in itself, may reveal something interesting about how norms and trust shape markets. “If you break these contracts, there’s not much that can be done to you,” Torfason says. “So one thing I’m looking at is, why isn’t [cheating] more prevalent?”

Virtual activity begs questions of theoretical enterprises like economics in just the same way real markets do. As independent and irrelevant as these virtual economies may seem, they are surprisingly reflective of actual economies. Though virtual banks may have no government backing or brick-and-mortar locations, virtual customers seem use them as if they did, looking for the banks with the lowest risk and the highest interest rates. Similarly, even though virtual consumers may be using currency to purchase intergalactic spacecraft or magic potions, economic principles of supply, demand, and consumer behavior still apply.

In fact, when the Great Recession hit in 2008 and American consumers began spending less to buffer themselves from economic uncertainty, so did those on Second Life, whose economy took an even worse hit even though there were no genuine threats to it. In virtual as in real economies, participants don’t always act rationally, and we learn a great deal about human nature by studying why that is. Still, that’s not the biggest reason economists are studying video games. With Americans spending a hefty $2.9 billion per year on virtual goods, real and virtual economies are far less independent than one might think.


[1] “The Economics of Video Games,” Brad Plumer, The Washington Post
[2] “Cheer Up, Ben: Your Economy Isn’t As Bad as This One,” The Wall Street Journal

Images via
The Washington Post
Eve Online
Jim Indore

  • http://www.slcapex.com Skip Oceanlane

    Banking may be banned, but Second Life still has a vibrant financial sector.  It should be noted that http://www.slcapex.com/ Capital Exchange Stock Market Simulation Game still operates and thrives within Second Life.  In January 2011 I took over the exchange and revitalized it – I also added new rules, regulations, and more importantly honesty and integrity.  We currently have 59 listed virtual companies and funds within the game, and companies are paying dividends.  We use the virtual currency of Linden Lab (“lindens – $L”) and we’re not to be confused with a real life stock exchange at all.  However, it’s a great way to learn how to buy and sell stocks and trading activity for 2012 is on track to reach about L$100,000,000 (about $500,000 US).

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