March 7, 2014

EVEconomics 101: Supply and Demand

Okay, so now that you're aware of where ISK comes from and where it goes, let's talk about what it does while it sticks around. There are a myriad terms, theories, models and systems to understand how money works, but one model is especially simple to understand and easy to apply: supply and demand. You have probably heard it before, and even run into a terse summary of it. Perhaps it went like this:

The more of something is available, the lower its price, and vice versa.
The more of something people want, the higher its price, and vice versa.

While that is technically true, the supply/demand model goes much deeper. To really "get it" though, you need to start from square one. So... let's examine the market for my favorite ship, the Rifter!

Not this one, unfortunately. It never made it to the market. :(

Who's in the market for Rifters?


Rifters are a limited resource. Sure, they can be easily manufactured, but nobody has a literally unlimited supply of Rifters. In the same way, there is a limited amount of people who want Rifters. Because of this, they have value! Those who can supply Rifters for sale are called producers, while those who would buy the Rifters are called consumers. A very important fact is that these two groups are dynamic, and may change at any time.

Producers are in it to make money. If the Rifter is viewed as a crappy ship and nobody wants it, you can bet there will be very few producers in the market. On the other hand, if the Rifter is popular, there will be tons of producers. The number of producers is largely irrelevant, though. What really matters is the answer to the question: "How many Rifters are producers as a whole willing to sell at a certain price point?" The answer to that question is called supply.

A producer desperate for materials to make more Rifters

Consumers, on the other hand, are in it because they want to use Rifters to do stuff. What that stuff is is irrelevant; all that matters is that the consumers have cash and potentially might buy a Rifter. How many actually will spend the money depends on the perception of "worth it". I know the most staunch Rifter-haters would buy huge piles of Rifters if they were only 1 ISK each, and even diehard Rifter pilots would stop buying Rifters if the price jumped too high. Whether the motive is price or usefulness, consumers are summarized with one question: "How many Rifters would consumers buy at a certain price point?" As you probably expected, the answer is called demand.

Do you see how vague and theoretical the questions defining supply and demand are? That's on purpose. Supply and demand are hard to assign numbers to, so for simplicity's sake basic analysis only looks at relative vague values, usually represented on sketched-out graphs without scales.

Supply

Lovingly mouse-drawn for your viewing pleasure

This is about as complicated as the graphs get. Notice the lack of numbers. Remember the question defining supply?
"How many Rifters are producers as a whole willing to sell at a certain price point?"
All this graph is saying is that as the price of Rifters goes up (follow the vertical axis up), so does the quantity available (the red line is farther to the right). If the price gets high enough, the amount of people who would want to make/sell Rifters would go through the roof.

What if the Rifter's blueprint gets tweaked to require more tritanium? Suddenly, fewer people will be willing to make/sell Rifters at the same price. Since the supply graph can only accommodate changes in price, not changes in the market, we need a new graph (old one kept as a dotted line):

That's a nerf. Had production been made easier in some way (such as adding more manufacturing slots to hisec stations), the line would instead move to the right. That would be a buff to production.

And now... a word from my sponsor.

Intermission

All that economics sure is thirsty work, isn't it? Quench your thirst with some refreshing Quafe Zero! Even the Rifter loves it!

The Mountain Dew represents how rich you will be if you drink Quafe Zero.

Demand

Now that that's over with, let's look at the other side of the market: the consumers. The question that we asked in order to define demand was:
"How many Rifters would consumers buy at a certain price point?"
The cheaper Rifters are, the more people would be willing to buy them. The reverse also applies. This is essentially the opposite of the supply curve, and results in a graph looking like this:

As you can see, the lower you move on the vertical axis, the higher the quantity of Rifters people will be able to buy. This is why, if you put 1000 Rifters up on the market for 1 ISK each, they will be gone within minutes.

What happens if the Rifter gets buffed, though? Naturally, its newfound power inspires people to be okay with paying somewhat more for their favorite frigate. The increase of demand in Rifters due to a buff is represented by a change in the graph similar to what you saw in the demand curve:

The graph moved to the right to show the increased demanded quantity because of the buff. A nerf would have caused movement in the other direction.

Putting it together


You are probably wondering what the point of these simplistic graphs is. To blindly layer them on top of each other, of course! No scale? No problem!


The most important part of this graph is that intersection point called the equilibrium. That is where the market will converge; the price and volume of a stable Rifter market is right. If a supplier tries to sell for a price higher than that (the upper dotted line), he will encounter lower demand than his competitors at lower prices, and won't sell as many Rifters. Conversely, selling at a lower-than-equilibrium point (the lower dotted line) will result in very quick sales due to high demand, but will lose the supplier potential money. 

How is this overcomplicated mess at all useful? 

It lets you speculate about a variety of fun stuff! For example, what will probably happen due to the Rifter buff? Remember the demand shift earlier? Let's put it on the compound graph.

There will be more Rifters sold at higher prices!

But maybe that's not impressive enough, because the original intuitive definition of supply/demand predicts the same thing. Let's look at some another situation that the supply/demand model simulates well.

Scarcity

Ever gone to null security space and tried to buy a Rifter on the market? Remember the sticker shock? Here's what's happening: the extremely poor T1 nullsec industry is causing an artificial cap on the maximum quantity of Rifters anyone is able to put on the market. That makes an entire area of the graph inaccessible.

Because the quantity of Rifters sold can't go over a certain threshold, there is little point for the producers to sell the Rifters at competitive, reasonable prices. From the consumer's viewpoint, that results in a market only open for those who are willing to pay a ton. That's not equilibrium, it's highway robbery!

What else?

This rabbit hole goes down much further, as supply/demand can be used to simulate resource cartels, market price manipulation, and can even be applied with money itself as the commodity at hand. Basically, it can be applied to almost everything you encounter here:



However, this blog post has gone on long enough. Tune in next time for talk of elasticity, and clues on how to abuse the market for fun and profit! Don't forget to buy your Rifters and Quafe!

Disclaimer for economist bittervets: the examples used were picked on a "simplicity", not "ultimate economic accuracy" basis. You are welcome to present better examples if you see fit.

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