Linden Labs, the operator of Second Life, has decided to increase the amount of virtual real estate in the game, causing a sudden drop in virtual land prices. This is interesting because in real life when cities expand the new land is at the edges, which is typically far from the more valuable centre, and probably has less of an impact on land prices overall.

In a virtual world, however, I guess that location is much less important. I don’t know exactly how people move around in Second Life, but in principle transportation in a virtual world from one location to another can be instantaneous and costless. In that case the distinction between ‘centre’ and ‘edge’ is blurry, and increasing the supply of land anywhere could affect prices everywhere, as appears to have happened in Second Life.

I guess there is a lesson here for real-world real estate investors. Improvements in transportation technology make cities more ‘connected’ and, everything else equal, should increase the correlation of real estate prices between different locations. My hypothesis is that with good transportation, extra land at the edges can have a significant effect on prices at the centre. It would be interesting to try to test this with some data.

(HT: UsableMarkets)

Scientific American has a nice article about virtual economies in games like Second Life.

Tyler Cowen is unconvinced about the value for real-world economics, though:

“I’m skeptical about using virtual worlds to do economics, at least as it is now,” says Tyler Cowen, who holds the Holbert C. Harris Chair of Economics at George Mason University. “What you do in experimental economics is you take undergraduates and put them in lab settings and play economics games and you measure the results. It’s like a created world, but it’s not in cyberspace. What makes experimental economics work is that you truly have a controlled experiment. When you have these virtual worlds, as I understand, people are not conducting controlled experiments. They’re running these onetime simulations. Whatever result you get is interesting, but you don’t know what to make of it. You’re stuck.

Personally I think the most interesting thing is figuring out what’s different about virtual economies and why. That might give some insights into how real economies work.

(HT: Lightspeed Venture Partners)

The thing about Second Life regulating in-game banking got me thinking a bit about why they have an in-game economy at all. I mean it’s a virtual world inside a computer. Electrons cost virtually nothing, so why not give game players whatever they want? Why make game resources scarce at all? Just give everyone unlimited amounts of everything.

Clearly, this would be a bad idea, because the game would quickly become very boring. When I was a teenager, I liked to play SimCity. There was a cheat code that you could use to get unlimited funds for your city. It was fun to play like that one or twice, but not very often. The whole fun of the game comes from optimising under constraint. Without the constraints, the fun is gone too.

Maybe I’m being too philosophical but I think there’s a lesson in here for life. Many people curse their constraints and of course it’s no fun living in poverty. But having everything you want, whenever you want it, might be quite boring too.

Some interesting news today that Second Life is prohibiting players from acting like banks in the game by not allowing people to offer interest or other forms of return on investment (whether in the game’s virtual currency, or in real currency), unless they are registered as a financial institution in the real world.

I guess this makes some sense - as the line between virtual and real worlds becomes blurrier, games become no longer just games, and can have real impacts on people’s lives. So some of the regulations that are necessary in the real world to protect people from scams and ripoffs, such as financial regulation, may be necessary in virtual worlds too. However, it would actually be an interesting experiment to see how big the problems were in Second Life’s financial markets prior to imposing this regulation. How well did the free market function?

I also can’t help thinking of the more cynical angle that these regulations are as much about protecting Second Life’s commercial partners such as Wells Fargo from competition as they are about protecting game players from each other.

The very real chief economist, Dr. Eyjólfur Guðmundsson, of the virtual online game EVE has released his first quarterly economic report based on game data. I can imagine it was quite a task to organise economic data from the game and analyse it, so this first report is not so ambitious and concentrates on basic statistics about game players and activities, as well as a few macroeconomic indicators. It also has the coolest pictures that I’ve ever seen in an economic report.

As basic as the analysis is, there are still quite a few interesting things. For example, the distribution of wealth as measured by the amount of game currency that players are holding is skewed, although not as dramatically as distributions of wealth can be in the real world. Second, and very surprisingly, over time there seems to have been both an increase in the quantity of game currency in circulation and deflation. I’m not a macroeconomist, but I thought increasing money supply is usually associated with inflation rather than deflation. The report presents various price indexes and the deflation has been huge - over 50% a year in some cases - while the quantity of money has increased more slowly but steadily.

Of course, the in-game economy doesn’t look like a real world economy in many respects, because it’s just a game and there’s a limit to the amount of realism that can be simulated. So the big question for me is, what aspect(s) of the game’s design have lead to breaking the relationship between increasing money supply and inflation? This could help us to understand the conditions in the real world responsible for that link. I’m also curious about what effect the massive deflation has had on the game’s economy. When prices overall are falling, this induces people to hold onto money rather than spending it, because money increases in value over time. This depresses economic activity, as people just sit on their cash rather than using it for transactions. With such significant deflation occurring, I would have thought that this would cause severe economic problems, and it would be interesting to examine that.

Aside from macroeconomics, I can think of many other microeconomic questions that would be interesting to look at. For example, are there any impediments to trade (eg asymmetric information, externalities etc) and if so how do the game players overcome these? Or do players make contracts with each other and how are these contracts organised? Have spontaneous markets emerged for things like futures and options? Is there a credit market and if so how is it organised? And so on … With so many interesting things to look at, and so much good data, Dr. Guðmundsson is a really lucky guy!