Why Behavioral Economists Love Online Games

If you've spent time on Facebook, you might be mystified by all the people tending to their virtual farms and virtual pets. I know I am. Not only does this seem a strange way to spend time, but here's the even weirder part: a lot of these people are spending real money to buy virtual products, like pretend guns and fertilizer, to gain advantage in these Web-based games.

But to Kristian Segerstrale this is very serious business, and not only because he runs Playfish, a maker of online games and a top seller of virtual goods. Segerstrale, an economist by training, says the world of virtual goods opens up a new way to study economics. "You can learn a lot about human behavior, and how people interoperate in an economic environment," he says. "There are a lot of valuable lessons."

Segerstrale, 32, grew up in Finland and studied economics at Cambridge University, then got a master's degree from the London School of Economics. After university, in 2001, he and some friends started a company to develop games for mobile phones. They sold that company in 2005.

In 2007, when Facebook said it would open its platform to outside developers, Segerstrale recognized this could be a great new venue for games. He and some colleagues created Playfish, adopting a business model in which the games cost nothing but Playfish would make money by selling virtual goods inside those games. Business boomed, thanks to games like Pet Society, which has nearly 20 million active users who make little animals and take care of them. Last November Playfish was acquired by the videogame giant Electronic Arts for $400 million. Playfish won't disclose its revenue or profits, but Segerstrale says the company sells 90 million items a day through its 12 different games. "I don't think anyone realized how quickly this was going to grow," he says.

The total U.S. market for virtual goods was worth just over $1 billion in 2009, according to Inside Network, a market-research firm. That's up from $500 million in 2008. The market will grow to $1.6 billion by next year, Inside Network says. Worldwide, the market may be worth as much as $6 billion, according to the Virtual Economy Research Network in Helsinki.

For Segerstrale the businessman, that's terrific news. For Segerstrale the economist, it's equally exciting. That's because when economists try to model behavior in the real world, they're always dealing with imperfect information. "The data is always limited, and once you get hold of it there are tons of reasons to mistrust it," Segerstrale says. In virtual worlds, on the other hand, "the data set is perfect. You know every data point with absolute certainty. In social networks you even know who the people are. You can slice and dice by gender, by age, by anything."

Instead of dealing only with historical data, in virtual worlds "you have the power to experiment in real time," Segerstrale says. What happens to demand if you add a 5 percent tax to a product? What if you apply a 5 percent tax to one half of a group and a 7 percent tax to the other half? "You can conduct any experiment you want," he says. "You might discover that women over 35 have a higher tolerance to a tax than males aged 15 to 20—stuff that's just not possible to discover in the real world."

The idea of studying behavior in virtual marketplaces is starting to catch on among academics. The focal point of the effort is the Virtual Economy Research Network, which serves as a kind of clearinghouse for scholars who are interested in studying virtual goods and virtual currencies. The organization was founded in 2006 by Vili Lehdonvirta, an economic sociologist at the Helsinki Institute for Information Technology who believes virtual economies could help scholars better understand how social factors influence economic decision making. CCP Games, creator of a virtual community called EVE Online, actually hired an in-house economist to regulate the economy of its online world, which has 330,000 members. "My role is like that of a lead economist in a central bank—I give information about the economy to the players and to CCP," says Eyjólfur Gudmagnusson, who was an associate professor at a university in Iceland before joining CCP.

One possible flaw in this economic model is that the kind of people who spend hours online taking care of imaginary pets may not be representative of the rest of the population. The data might be "perfect" and "complete," but the world from which it's gathered is anything but that.

Daniel Lyons is also the author of Options: The Secret Life of Steve Jobs and Dog Days: A Novel.

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