Thursday 28 June 2012

Clearing up some misconceptions about inflation and deflation on the auction house (a quick economics lesson!)

Various commenters and streamers have been discussing inflation in the economy of Diablo 3, but I think there's a lot of misinformation being spread that I'd like to try to correct. Keep in mind I'm simplifying some more advanced concepts here for clarity.
What is inflation? Inflation simply means a general rise in the price of goods. When people talk about "gold inflation" in Diablo 3, what they mean is that they perceive items in the gold auction house as generally rising in price.
What is deflation? The opposite; a general decrease in the price of goods.
How are average prices (values) determined? While anyone can list any item for any price, the true value of an item is determined by simple supply and demand. But what does that mean exactly?
The demand curve refers to the price points buyers are willing to pay for a given item. There are more people lower on the curve, naturally. Virtually everyone would pay 1000 gold for a 1000dps 1h weapon, but almost no one would pay 100m gold. The demand curve itself can be affected by various factors, more on that later. . The supply curve refers to the price points sellers are willing to sell their goods at.
The intersection of these two curves is the 'equilibrium price', or the true value of a given item (type). If quantity sold is "q" and price is "p", the equilibrium price is the point at which q*p is highest. All things being equal, markets such as the auction house gravitate toward the equilibrium price. This is fairly intuitive, but important later.
What affects supply and demand? Demand and supply curves can each be shifted left or right. When demand moves to the left (less aggregate demand), prices decrease. When it moves to the right, prices increase. When supply moves to the left (more aggregate supply), prices fall. When it moves to the price, prices rise. Here are some examples.
Aggregate demand INCREASES (prices rise) in Diablo 3 when...
  • The supply of gold among buyers increases (gold is generated 'from thin air' all the time, thus this is constant)
  • More people start playing the game
  • People get more geared, decreasing the chance of FINDING upgrades and making the AH the superior option for upgrades
  • Certain types of items become more desirable via patches (for example, crit)
Aggregate demand DECREASES (prices drop) when...
  • People choose to shop at the RMAH
  • People stop playing the game
  • People become geared to the point where they no longer need upgrades
  • The supply of gold among buyers decreases (via transaction costs, repair costs, combining, etc.)
  • Certain types of items become less desirable via patches (for example, attack speed)
Aggregate supply INCREASES (prices drop) in Diablo 3 when...
  • People farm and craft more items (this is also constant)
  • More people start playing the game
  • The rate of items being farmed/crafted is increased/made easier via patches and/or new farming routes
Aggregate supply DECREASES (prices rise) when...
  • Suppliers choose to sell on the RMAH
  • Drop rates are decreased, craft costs are increased, ITEM farming spots are nerfed
  • People stop playing the game
What does this have to do with gold inflation and the value of items? Inflation is not as simple as "there's more gold, therefore prices are rising". As you can see from the small list above, there are both inflationary and deflationary pressures being applied constantly. Though more gold is constantly being produced (leads to higher prices), there are also more items being farmed (leads to lower prices).
Also, keep in mind that supply and demand curves exist for specific markets and types of items. Some people point to very high-end weapons rising in price as an example of inflation, but this rise can be attributed to a number of factors:
  • Decrease in ilvl63 droprates from Blizzard
  • Increase in # of sellers using the RMAH
  • Increase in # of people seeking high-end weapons (eg. more people reaching late Inferno)
Meanwhile, in other markets, such as attack speed rings/gloves, you have prices dropping as a result of the attack speed nerf by Blizzard. All attack speed items have decreased in value primarily because their demand curve has shifted left. Additionally, 700-800dps 1handers and 900-1000dps 2handers have had consistent deflationary pressure for reasons such as:
  • More people reaching lategame Inferno and seeking more powerful weapons (eg. demand for weaker weapons is lower)
  • Continuously greater supply of these weapons, now farmable in all acts, relative to the # of people needing them
Though this is a basic overview, there are some points you should take away:
  • Just because prices on SOME items are rising, doesn't mean this is a trend that will continue forever, or that all items are experiencing price inflation.
  • Investing in items as an alternative to gold is not necessarily logical. Even in the real world, the price of fixed-supply commodities like gold fluctuate in value considerably. Diablo 3 items are NOT fixed supply (more are produced every second) and are definitely not immune to fluctuation in value.
  • The constant influx of gold to the economy via farming (vendoring items, dropped gold) is to varying degrees counterbalanced by gold sinks such as repair costs and transaction fees as well as a continuously increasing supply of items.
  • The RMAH does not necessarily cause pure increases or decreases in price on the GAH. Though some suppliers left the GAH (decreased supply -> higher prices), so did some buyers (decreased demand -> lower prices). Time will tell how this pans out.