Sunday, January 30, 2011

King Arthur and Opportunity Cost

One of my favorite movies is the 2004  King Arthur (Clive Owen, Keira Knightley) Not only is it told with an interesting twist on the Arthurian legend but it also contains one of my favorite movie scenes of all time.

Arther and his knights are escorting a Roman noble and his family to safety ahead of the invading Saxons. They must complete this task to earn freedom from their servitude to Rome. In his benevolence, Arthur chooses to escort the noble's vassals in the evacuation. This act of kindness slows their escape dramatically--what with oxen pulling carts, elderly and nearly crippled peasants and the only horses belonging to Arthur and his knights.

Unencumbered and hungry for a fight the Saxons march all night and at a much more war-like pace. Finally, the Saxons are nearly upon Arthur and the procession as the escape route runs smack into a frozen lake in the mountain pass. With no way around, they must cross it--slowly, because the combined weight of too many knights in one spot may crack the ice and plunge them to their deaths.

Arthur sends the noble and the remaining procession forward to Hadrian's wall whilst he and his knights stand to battle the Saxons upon the frozen lake. Outnumbered 25-1, the knights prevail with only one casualty.

But what does this have to do with opportunity cost?

In its purest form, an opportunity cost is the loss of an alternative course of action that occurs when a different course of action is chosen. Most often we think of opportunity cost in terms of financial choices--investment, jobs, or even earning gold in WoW. But it also applies to Arthur in this movie scene.

His choice is to stand and fight despite being horribly outnumbered. His opportunity cost is that of moving closer to reaching safety at Hadrian's wall. Other choices were also eschewed--setting traps for the Saxons, waging guerrilla warfare against them as they marched, slowing the invaders so that the caravan could make it to safety, etc.

The Challenge

Similarly, our choices of how to earn gold in WoW are zero sum choices--the are mutually exclusive due to time. One cannot both gather herbs AND craft glyphs at the same time. The choice to do one or the other makes the one not chosen the opportunity cost of the other selection.

Because in WoW we can gather herbs and THEN go mill them, make ink, buy the parchment, craft the glyphs and list them in the AH many players get confused by thinking the materials did not cost them anything. No gold was actually expended, right? These players believe that since they gathered the materials themselves they "saved" the cost of purchasing them on the AH. And this line of thinking can also further degrade the AH economy by leading players to dramatically undercut auctions, which can hurt everyone.

Here's a simple example using one stack of Elementium ore. Two players are involved, both starting at the SW auction house. Who earns more?

Two Paths Diverged in a Lonely Wood....
If Player A travels to Twilight Highlands and farms the Elementium himself he may spend a couple minutes flying in Stormwind to the portal, then port into the zone and fly around competing with bots or other farmers. Gathering this one stack of ore takes Player A 11 minutes overall. No actual gold left his coffers--he is instead out 11 minutes time.

Player B walks into the AH and buys a stack of Elementium ore for 80g, goes to the mailbox and collects it. 80g has left his purse and he also spent about 30 seconds buying and collecting this ore--we will say 1 minute.

From this point forward there is no difference in their experiences--both will prospect the ore, buy Jeweler's Settings, go to the forge in the Dwarven District, make their Carnelian Spikes, DE them, and list the products on the AH. Further, we will say the ore prospects into 9 Carnelian gems. Granted, in actual game experience any one of six basic gems will proc. Getting 9 gems from one stack of ore isn't unlikely--for the example we are saying we get all the same kind, and moreover, valuable Carnelians.

Each player spends 10g 80s on the Jeweler's Settings. Each player receives the same 9 Greater Celestial Essence upon DE'ing the Carnelian Spikes. The AH lists 54 auctions of Greater Celestial Essences ranging from 49g to 59g. Each player decides to list his Greater Celestial Essences at a price that should sell quickly. Each settles on 46g, below the lowest price in the AH, making the total listing worth 414g. These sell for each player in an hour or so. They each go to the mailbox and collect 393.2g (after the AH fees).

Player A will say he made 383g after expenses (the Jeweler's Settings). Player B will say he made 303g after expenses (the initial cost of ore plus the Jeweler's Settings). Who actually did better? Let's compare.

And The Winner Is....

The opportunity cost for Player A is 80g that he chose not to spend; the opportunity cost for Player B is the 10 minutes he didn't spend on farming. What did Player A do with the 80g he saved by farming? What did Player B do with the 10 minutes he saved by buying retail? That comparison holds the key.

If Player A used that 80g to buy something to flip for 100g, then his incremental revenue is another 20g. If he used that 80g to buy a new weapon, then the weapon becomes incremental value. Or if he just held the 80g in his bank he earned no incremental value. He netted 383g and no more.

If Player B used the 10 minutes he saved to quest, then he gained experience and reputation as his incremental value. Or if he chose to run one of the dailies in SW his incremental value earned was the cooking token, or jewelers' token or whatever.

But let's assume Player B is a goblin. He instead uses his 10 minutes saved time to replicate his original investment. In 10 minutes he saved farming he is able to purchase, prospect, craft, disenchant and sell mats from 3 additional stacks of ore. In our original example, the stack of ore prospected into Carnelian gems. Let's say the 3 additional stacks prospect into other gems so the actual net from each stack is less--say 150g/stack. Player B then used his 10 minutes to generate an additional 450g in profit.

So who did better? Player A kept 80g in pocket but Player B earned 450g additional profit, or 370g net net over Player A.

Is Farming Ever Viable?

Don't get me wrong--there are times when farming is a great strategy. If you are questing in a zone and mine every node you find as you travel then you are only out the few seconds it takes to detour and collect the node. Farming is made even more attractive if you are leveling since you will earn experience for the nodes you mine.

Or if you are farming in a deserted zone or at some off-hours time when no one is around you may not have competition for nodes. This makes your yield higher than normal. Or you may not have liquid capital in sufficient quantity to purchase from the AH, or the prices of what you need are so high that you can't make a profit unless you farm it yourself.

Or maybe you just like farming.

If any of those reasons are why you farm then good for you! Enjoy your play experience. Farm your pixilated ass off.

But realize that in so doing you aren't collecting materials for free--there is a cost associated with the time it takes you farm. And you have to calculate that cost, that missed opportunity, in your pricing and sales decisions.

Deep Undercutting: The Logical Fallacy

Further damage occurs when the "I farmed it so it is free" fallacy is then misapplied by the deep undercutter. This player decides that the Hurricane scroll he can enchant with the Greater Celestials that he generated in the above example were "free" so he undercuts the seller in the AH by around the value of the Essences. In other words, the two Hurricane scrolls listed are at 950g each, but the deep undercutter says "hmm, I saved 380g by farming and DE my own mats--I'll list my scroll for 575g".

By failing to calculate the opportunity cost involved this player actually loses money. He spent 10 minutes farming (thus missing out on 450g incremental profit in our example above). He also misses out on the 383 net profit he would have made for listing the Essences instead of crafting. Opportunity cost burns him twice--farming  time and using the Essences to sell as materials. His actual break even for this scroll is 383g plus 450g, or 833g. Break even. 950g would give him roughly 120g in profit. But he sells at 575g which is a net loss of (833-575) 258g.

Let me say that again: he suffers a net loss of 258g. And that assumes he already had the Heavenly Shards needed to craft the scroll.

But not only does he suffer a loss, he is deluded into thinking he has earned a profit--after all, he didn't spend any gold directly for the Essences so he feels this cost can be subtracted from his profit calculation.

But What Do We Learn? Hopefully Something.....

If the AH worked like a real market we would just say "let him operate at a loss and he will suffer the consequences". But it doesn't and he won't. Players have a single choice for purchases--the AH. And when a third player wants to sell his Hurricane scroll and sees listings of 950g, 950g and 575g, he naturally will list at 575g or less. Now the 950g auctions expire. Their sellers re-list at 560g. And so on. Profits eroded for all based on a stubborn player who doesn't understand opportunity cost.

I've rambled on long enough. I'm not opposed to farming, and I do believe deep undercutting can be viable in some situations. I really hope that more players will begin to understand opportunity cost and how it should affect their pricing decisions. The challenge is explaining to "Hurricane Posting Guy" above that when his bank account increases 575g he is actually losing gold.

Arthur and his knights were willing to suffer the opportunity cost associated with making a potential last stand on that frozen lake. After all, they were fighting the valiant fight, for justice and for the less fortunate. Had they died (spoiler: one does) they would have done so willingly--theirs was the greater good.

There is no similar "greater good" in the AH. We all want to make gold, to generate income for its own sake or to fund our other needs in game. Let's just try to be mindful that every choice we make has a cost associated with it. Let's hope we calculate these costs appropriately so that our market becomes more stable.

At best, it will take a long time. At worst, things will stay the same.


  1. nice post and nice analogy.

    You post good stuff man, get back into it :D

  2. Thanks Smudger....glad you liked it.

  3. "Quoting: And when a third player wants to sell his Hurricane scroll and sees listings of 950g, 950g and 575g, he naturally will list at 575g or less. Now the 950g auctions expire. Their sellers re-list at 560g. And so on. Profits eroded for all based on a stubborn player who doesn't understand opportunity cost."

    All this is based on the assumption that the so-called smart sellers know for sure that 950g is the "right" price for this item, considering the current supply and demand. I think those who re-list at 560g (instead of simply buying the 575g items of the stubborn seller to repost them at what they perceive as the right price) share as much of the blame. After all, if the smart sellers read the market correctly, the items would still sell at the higher price. If they do not, then maybe 950g is not the right price after all.

  4. Awesome post Kammler! That scene from King Arthur is one of my favorites as well. I'm so happy to see some new posts from you as they are always intelligent and a pleasure to read! :)

  5. @ Gob: you are correct--I made an assumption that was not articulated in the post. The original version did spell it out more clearly but was cut due to the length of the article. The assumption is that the scrolls are selling all the time at 960g. In the example I used such was the case: I sold one or two a day at that price or very close. Then the lower price came in which re-set the market for a while.

    Also, to your point: the correct price can be said to be the price it sold at--575g was right for that sale, 960g for the next. Given that it is a relative condition, my point is more about the long term market value (histogram pricing model) than it is for a single sale.

    Point being: if sales can be had at ~950g but not at 1050g then it can be said the market will tolerate a 950g cost. A 575g sale is by any measure then a "good deal" for the buyer--but a money loser for the seller.

    Excellent points though.

    @ Miss Mediocre: Glad to hear you are reading! I have been "out of the game" for too long. I'm now inclined to post less but in greater detail. Hopefully you will continue to be entertained!

  6. Your posts are exceptional well done, your perspective is impressive, how the hell you do this :) , you must share your secret, ok just kidding.
    Great post mate.

  7. Thanks Alberthus. I always like comments, and really appreciate my readers.

    There is no secret. Just don't have a life. lol.

    Love the game, write about things that matter to you--that's the best way to start.

    Hope you keep coming back.

  8. You can bet all your gold that i will be back ,no more then ever.