Greedy Goblin

Wednesday, December 24, 2008

Opportunity cost

The largest and most common error of poor people is not understanding opportunity cost. If you want to belong to the middle economic class of WoW, you must understand opportunity cost.

In several actions no money is involved, so you may think that it's "free". However by taking an action, you naturally exclude all other opportunities. Opportunity cost is the price of these lost opportunities.

Basic example: you find a BoE item and Auctioneer addon says it's usually 1000G in AH. Your options:
  • equip it
  • put it to the guild bank, offer it on guild channel
  • sell it on the AH for 1000G
In the first two options, no money is involved, so you feel that it was free. However by choosing these you make the third impossible, so you lose that 1000G. 1000G is the opportunity cost of these actions. If you still don't understand it look at the following options:
  • you give the ring to a guildmate for free
  • you sell the the ring in the AH for 1000G, give the 1000G to a guildmate as a gift and he buys a different piece of that ring for 1000G
Notice that the options are equal. In the second scenario you both get and lose 1000G.

Of course you can equip or gift a ring. However you shall always be aware that in that moment you lose 1000G. If you still want it, it's your call. If you don't know about it, you are making a huge mistake.

Typical example of this huge mistake: someone with and expensive crafting profession, leatherworking, blacksmithing or alchemy says that "leveling these does not cost anything since I'm also a skinner/miner/herbalist". Of course it's nonsense. His herbalist part collected herbs worth thousands of golds and his alchemist part spent it all. If he had been herbalist but not alchemist, he would have this money as cash.

Every time when you are about to equip or gift an item, or use a material for tradeskill, move your mouse over it, and watch its price in the Auctioneer tooltip window! The money shown there is the opportunity cost of the planned action. You could get this money if you would sell the item. Be sure you really want to lose this amount, before you use the item.

Gifting an 1000G worth ring away is a bit extreme example. So here comes two common examples:

You want a crafted item. You have the materials. Check both the material and the item prices. If the item is more expensive, you shall craft it. If the materials are more expensive, you shall sell the materials, and buy the same item from the AH.

Putting an item into the bank seems harmless. However the opportunity cost is the same. By not selling the item, you abandon its price. Yes, you may can sell it later. But you may not. Or just for cheaper. Holding an item is only smart if you expect its price to increase. If you expect it to decrease, sell it now and buy one cheaper when you need it. Poor people tend to have full banks and several bankalts for their stuff. All my stuff fits into 3!! bags. Everything else is making me money.

8 comments:

Esdras said...

Im turning into a bit of a miser haha.

Its good though because i was a bit like if i needed something i would go earn to get it but now i can buy it from what i have and just top up my fund.

Knife said...

I used to make money with auctioneer by buying twink/blue/purple items when they're cheap (or stupidly priced) and selling them higher. With WotLK people seem to be ignoring their twinks and, i had thought, it was tougher to make money...then i started reading your site.

Within the first week of WotLK, people were getting a slew of random drop BoE stuff and selling it for huge chunks of cash on the AH. There was always the stuff that was priced way to high. It was then I truly saw the impatience of people, their underlying stupidity, and (based on your recent weeks of posts) that most of them were actually poor people who got lucky.

I started with 2500g going into WotLK. The first two days of the X-pack, someone on my server had obtained and was selling the Tears of Anguish (purple lvl 80 boe trinket) for 12,000g. It didn't sell. He then dropped the price (two days later!) to 6,000g. He/She kept dropping the price by 30-50% during the week because the item wouldn't sell. I obtained it for 450g and am, i believe, the only person on the server to have it...in my bank.

The item wouldn't sell not only because no one wanted to pay 12k-g for it, but also because not many people could use it. Now, a little over a month later, there are quite a few lvl 80s hungry for purples and willing to pay.

The point is, you might want to say something to this in your post. Having things in your bank isn't necessarily a bad thing. Part of business is knowing when to sell things and when to hold them. You can't sell a gold-plated nativity for $200 in the middle of summer, but you can easily sell it for $300 in December. You also don't want to fall into the trap of reducing your prices during the work-week on items that aren't selling. If it doesn't sell at the current price in an entire weekend (thursday-sunday...gotta play to those college kids) then lower it the following weekend by a nominal percentage.

I also wanted to alert people to a potential business opportunity-
The crystallized-eternal thing is going well on my server, but it's slowly fading. What's the new way to prey on lazy people? Leather, if you're a LWer.

20 borean leather is going for 11g on my server, while 20 heavy borean is going for 90-115g. 6 borean = 1 heavy. Do the math. (120 borean for 66g -> 20 heavy for 66g which sells for 100g.

There is also a massive rush on low-mid level herbs (duh), however outlands herbs are the cheapest i've ever seen them. Dreamfoil going for 4g a stack? Ragviel, ancient lichen for 2g? Thanks. Seems my server preys on entry level inscriptors but fails to capitalize on outlands-level. My turn.

Thanks for the great blog. I read it all the time.

Gevlon said...

@Knife: this post was filed under "middle class". These are NOT for businessmen. These are for people who don't know and don't want to know trends, just want a decent income for their work. These advices won't make them rich. It will make them OK.

Anonymous said...

Gevlon, I was recently made aware that botting is still very much alive in the game. An individual boasted that he bought a new account and just left the bot running over night until he hit 80 and then proceeded to farm en masse while he was sleeping, sell the items in the morning, and transfer the gold over to his main account with no risk to himself.

Could you comment on this situation? What parallels occur in real life? Are these individuals effectively printing and pouring money into the economy, causing inflation and lowering the net purchasing ability of those who play within the rules of the game? What can Blizzard do to stop them?

Gevlon said...

@anonymus: http://greedygoblin.blogspot.com/2008/09/gold-buyers.html

Stripes said...

It isn't allways right to buy an item when mats cost exceeds the finished product cost.

If the item will/can level your tradeskill AND having that skill higher is likely to have a good return. For example if eternal belt buckles sell for far more then mats cost then it can be worth it to turn 1000G of mats into 100G of items just so you can start turning 20G worth of mats into 70G of buckles.

At least if the belt buckle handles you making that 50 G profit more then 18 times :-)

Anonymous said...

I feel like this post is slightly deceptive, in that it's not actually about opportunity costs, but rather realistically evaluating the worth of the items in your inventory.

An opportunity cost is only the cost of the next most preferable course of action. So, for example, in the first example of:
equip it
put it to the guild bank, offer it on guild channel
sell it on the AH for 1000G
if you're most inclined to do the first, but more inclined to do the second than the third, the opportunity cost is only the deprivation of the item from your guild, not the 1000g that you would have gotten from selling it. That certainly doesn't make the item worth any less than 1000g, though.

Kurt said...

"if you're most inclined to do the first, but more inclined to do the second than the third, the opportunity cost is only the deprivation of the item from your guild, not the 1000g that you would have gotten from selling it."

Since you want to get technical, if your first preference is to equip the item, then probably your precise opportunity cost is the next best item you could have bought to equip by selling the item.

Gevlon's definition of opportunity cost, "Opportunity cost is the price of these lost opportunities.", while not the normal one, is a useful concept. Call it the monetary opportunity cost, instead of the next best alternative, it's the alternative with the highest monetary value. This definition is easily derivable from the normal opportunity cost by looking at the monetary opportunity cost as the opportunity cost of choosing from among the set of better alternatives that have a lower market price. That is basically exactly what Gevlon does, just without complicating it to the average reader by introducing these definitions.

My point is, that opportunity cost is the next best alternative, from a finite set of alternatives. I.e., if I ask you to choose between 4 alternatives, you sit down and calculate that one will eventually be worth 4 dollars, one 6, 7, and 10, you pick the 10, and say that the opportunity cost is the 7, for a benefit of 3 dollars over the next best choice. If that calculation takes you 2 hours, and your time is worth 150 dollars an hour, than you see that the opportunity cost of figuring the first opportunity cost is so high that you would have been much better off picking from a hat, and the only reasonable answer to my first question, given that the order of magnitude of time to calculate and value of the alternatives is immediately apparent, is that I was asking the wrong question. Someone whose first preference is to equip the item, second preference is to put it in the guildbank, third preference is to offer it on the guild channel, fourth preference is to sell the item, may have the wrong preferences altogether... in effect, he is asking the wrong question.