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Virtual Economies

Virtual Economies: Design and Analysis

Vili Lehdonvirta
Edward Castronova
Copyright Date: 2014
Published by: MIT Press
Pages: 312
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  • Book Info
    Virtual Economies
    Book Description:

    In the twenty-first-century digital world, virtual goods are sold for real money. Digital game players happily pay for avatars, power-ups, and other game items. But behind every virtual sale, there is a virtual economy, simple or complex. In this book, Vili Lehdonvirta and Edward Castronova introduce the basic concepts of economics into the game developer's and game designer's toolkits. Lehdonvirta and Castronova explain how the fundamentals of economics -- markets, institutions, and money -- can be used to create or analyze economies based on artificially scarce virtual goods. They focus on virtual economies in digital games, but also touch on serious digital currencies such as Bitcoin as well as virtual economies that emerge in social media around points, likes, and followers. The theoretical emphasis is on elementary microeconomic theory, with some discussion of behavioral economics, macroeconomics, sociology of consumption, and other social science theories relevant to economic behavior. Topics include the rational choice model of economic decision making; information goods versus virtual goods; supply, demand, and market equilibrium; monopoly power; setting prices; and externalities. The book will enable developers and designers to create and maintain successful virtual economies, introduce social scientists and policy makers to the power of virtual economies, and provide a useful guide to economic fundamentals for students in other disciplines.

    eISBN: 978-0-262-32331-4
    Subjects: Economics

Table of Contents

  1. Front Matter
    (pp. i-vi)
  2. Table of Contents
    (pp. vi-x)
  3. Acknowledgments
    (pp. xi-xii)
  4. 1 Introduction
    (pp. 1-22)

    Lionel Robbins, a former head of the economics department at the London School of Economics, definedeconomicsas follows: “Economics is the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses.”

    Scarcity is a central concept in economics. It means that something exists in a lesser quantity than would be required to satisfy all desire for it. Not everyone can have everything; people need to make choices. Economics studies those choices, and the patterns or laws of give-and-take that emerge when many people make such choices in interaction with each other. A...

  5. 2 Theories of Human Behavior
    (pp. 23-40)

    Although economic discussions focus heavily on such inanimate things as goods and money, economics is fundamentally a social science: a science that studies the behavior of people. All economic theories, even if on the surface they talk about entities like markets and supply curves, are essentially theories about how people behave in interaction with each other in different situations. In this chapter, we introduce the fundamentals of how economists as well as some other social scientists think about human behavior. In later chapters, we use these ideas to understand how larger formations like markets and entire virtual economies work.


  6. 3 Goods: Material, Digital, Virtual
    (pp. 41-56)

    In the previous chapter, we looked at economic agents and how they make decisions. We showed how to predict the consumption of ice cream using the rational choice model. The same model can be used to predict consumption in a virtual economy, but the goods available in a virtual economy are very different from ice cream. In this chapter, we ask, “What exactly are virtual goods, and why are people attracted to them?” This will help us both understand user behavior and design effective virtual goods, the second building block of any virtual economy.

    In the widest economic sense of...

  7. 4 Supply and Demand
    (pp. 57-82)

    This chapter begins a four-chapter series in which we focus exclusively on markets, the iconic institutions of modern capitalist economies. In game parlance, the wordmarketusually refers to a centralized marketplace, like an auction house inWorld of Warcraft. In economics, the word has a slightly different, wider meaning. It encompasses all trade for a given good and its substitutes within a given region, regardless of whether that trade takes place through auctions or other means. In this chapter, we focus on the basic model of a free market, known as perfect competition. The closest real-life counterpart of this...

  8. 5 Regulating Markets
    (pp. 83-100)

    In the previous chapter, we introduced an ideal model of a competitive market, where anyone can join the market as a buyer or a seller and prices emerge freely from their interaction. However, most markets in virtual economies are not like this. Most are in one way or the other regulated by the publisher. For example, publishers often reserve the right to act as the sole supplier of premium virtual goods in their economy. No one else is allowed to compete with them. And in many ostensibly competitive markets, publishers actually enforce minimum or maximum prices, such as when nonplayer...

  9. 6 Market Power and Pricing
    (pp. 101-120)

    In this chapter, we go in detail into the concept of market power: what it is, how you obtain it, how you fight it, and what you can do with it. As is the case with many of the learnings in this book, the contents of this chapter can be applied on two levels. On one level, they can be applied in the internal design of a virtual economy. On another, they can be applied in the overall business of digital content publishing. The examples in this chapter are of publishers’ wielding market power against each other, but the same...

  10. 7 Methods of Exchange
    (pp. 121-136)

    In this chapter, we return to the internal workings of a virtual economy to address a practical design question: What kind of mechanisms should we provide to users for carrying out trade? Storefronts? Auction houses? Or something much simpler? Recall that in chapter 4, we said that a market can consist of any arrangement through which buyers and sellers meet for the purposes of exchange. In chapter 5, we talked about who those buyers and sellers are on different kinds of markets. We left open the more practical question of how the exchange actually takes place. In this chapter, we...

  11. 8 Externalities and Secondary Market Trade
    (pp. 137-154)

    In this chapter, our theoretical focus moves away from markets and into the concept of externalities: costs and benefits caused by an action to a third party. In terms of practical subject matter, we nevertheless continue with markets, as the topic of the chapter is applying the theory of externalities to analyze unsanctioned secondary market trade of virtual goods.

    The termsecondary market traderefers to users’ trading virtual goods between themselves for real money. The first virtual goods secondary markets consisted of MMO players trading game items and characters on Internet auction sites like eBay. Since then, similar real-money...

  12. 9 Institutions and Nonmarket Allocation
    (pp. 155-176)

    Much of economics is concerned with the functioning of markets, but markets are not the only way by which resources are allocated. Companies and organizations distribute goods and services internally according to their own hierarchies. Parents provide food to their children without demanding anything in exchange. Governments levy taxes to provide public goods and social welfare. Criminals steal wealth from others to consume it themselves. These are examples of nonmarket institutions and allocation mechanisms, which we focus on in this chapter. In ancient economies, nonmarket allocation was the norm and markets the exception. In today’s national economies, markets are emphasized,...

  13. 10 Money
    (pp. 177-196)

    Money is ubiquitous in today’s societies. In virtual economies, however, this assumption does not always hold. Money might not exist, or it might come in forms that are rare in national economies. In this chapter, we take a step back and examine the fundamentals of money: what money is, what it is needed for, what makes good money, and what types of money there are. We also look at how designing money for a virtual economy differs from designing money for a national economy. We touch on the macroeconomic aspects of money, but leave detailed discussions of monetary policy to...

  14. 11 Macroeconomic Design
    (pp. 197-214)

    So far in this book, we have dealt with different components that make up a virtual economy: agents and their behavior, goods, markets, institutions, and money. In this chapter, we are ready to consider how these components combine to form a virtual macroeconomy. Along the way, we also introduce two more sets of building blocks that are crucial to almost any virtual economy: faucets, which introduce new goods and money into the economy, and sinks, which remove goods and money from circulation.

    In our economics studies, we learned a conceptual model for the entire economy that was supposed to help...

  15. 12 Macroeconomic Management
    (pp. 215-246)

    In the previous chapter, we showed how to build a virtual macroeconomy by combining various building blocks. In this chapter, we look at how to manage a live virtual economy. The main issues that we need to deal with are how to measure the status of a virtual economy, how to steer it in a desired direction, and how to know what that desired direction is in the first place. Along the way, we look at some of the ways in which national economies as well as corporations are measured and managed.

    First let’s consider virtual economy management from the...

  16. 13 Policymaking
    (pp. 247-260)

    In this chapter, we discuss practical questions involved with implementing an economy in a virtual world. The issues are the same as in the offline environment, although the powers of a virtual economy designer are greater. The great power of virtual economy owners is not as helpful as one might think, however. Merely being a dictator does not make it easier to govern well. There is much more to good policymaking than rolling out new code.

    We saw in chapter 12 that there are many tools for managing a virtual economy. Those tools by themselves do not tell a manager...

  17. 14 Why the Real World Needs Virtual Economy Design
    (pp. 261-272)

    The global economy is in trouble. Besides constant financial crises, stagnation, unemployment, and poverty, the economy is starting to face an even graver set of problems: dwindling natural resources and a looming global environmental disaster. The International Panel on Climate Change estimates that in order to avoid a catastrophic level of global warming, we need to cut global carbon emissions not by a quarter, not even by half, but by up to 85 percent over 1990 levels by 2050.¹ Even before that deadline, we are likely to see more and more wars and struggles over increasingly scarce natural resources, such...

  18. References
    (pp. 273-280)
  19. Index
    (pp. 281-294)