Playground Economics

With chikungunya on its way out, it seems, another bug will soon strike our playgrounds. The Germany 2006 bug. I wonder if kids still collect and exchange Panini football stickers, but I loved 1982, 1986 and 1990 for that. I still remember that afternoon in 1986 when opening a pack, I was rewarded with the most prized of all earthly things: a picture of that chubby bloke in the white t-shirt with bluestripes, Diego Armando Maradona! For an economist, the playground is a wonderful laboratory. Sadly, when I tell my students that they should understand simple market mechanisms at work around them, before they go on to study fancy derivative or commodity markets from the other side of the world, some look at me with staring eyes.

For those from the Playstation generation, here is the rough guide to the market for football stickers. The ultimate aim is to complete a collection book with slots for around 300 stickers, that are randomly packed and sold in bundles of 4 or 6 (Rs 2.00/$0.10 per pack of 6 in the old days). Unlike Pokémon cards where certain cards are made deliberately rare by the supplier, here Panini ensures a perfectly random allocation, which means that one is bound to get duplicates. As duplicates are of no value for the purpose of the collection, there is a ’secondary’ (i.e. an exchange) market, the playground, where kids trade.

There are, in fact, two types of traders in this market. There are the ones who only aim at completing the collection and therefore value a sticker in relation their personal needs. They are said to assign a private value to the sticker (to use the language of Finance, one can call them the ‘fundamentalists‘). There are those who value a given sticker according to the popularity/ability of the football player whose picture is on the sticker (call them the ‘speculators‘). Notice that some kids (I was one) can be both fundamentalists and speculators at different times depending on the portfolio of stickers they hold. Nevertheless, without speculators, the market for stickers would clear very quickly and kids would soon be able to fill their book. Why? Because the law of large numbers ensures that in a large enough group of kids, what is random for one kid, is no longer random for the whole group: all of the stickers will eventually be found for all of the kids and it is just a matter of them exchanging hands enough times.

In the presence of the speculators, things get messier. Speculators withhold the Maradonas to drive up their prices and trade only the Kim Jong Bus (a Korean player who still plays 1 million times better than me). Gresham’s Law is operating: the bad players drive out the good ones. Gresham was a 16th century English chap who observed that, when the Queen was putting new metallic coins in circulation, they tended to disappear because people had a tendency to store them and circulate old, worn-out coins instead.

The question is: why aren’t the stickers of good players traded at a higher price than those of bad players enough to induce the speculators to release them? They actually are (sometimes the exchange rate can attain 25 to 1), but not high enough to the taste of the speculators. That’s because the fundamentalists, who are not interested in the quality of the players, are not ready to pay the high price. Disappointed, speculators withhold. So, in fact, the bad players are driving out the good, as the latter are not rewarded properly. This is similar to the phenonemon of adverse selection that one observes in many, many markets. Adverse selection occurs when owners of items that are of high value are discouraged by the low price, because the buyers are unable to realise their true value. A classic example is the second-hand car market, where bad cars drive away good ones because owners of the latter rightly believe that their cars are being underpriced.

Among the speculators, one can find the well-endowed (a kind term for the ‘fils à papa‘) and the less-well endowed. One could expect the well-endowed to be splashing the hard-earned money of their parents on stickers. Some crazy ones did, but surprisingly most didn’t. Two interrelated reasons why: (1) there is uncertainty about of future value of the good players (2) the playground is a small market.

To understand this, one has to realise that the climax occurs during the World Cup itself, and that’s when the bulk of the transactions takes place. Those who love football will know that almost anything goes; big teams leave the Cup early, small teams create havoc, big shots get injured in the first match, etc. Hence, team or player popularities change with their change in fortune. How good is it then for the well-endowed speculator to be buying in bulk and speculate when he is faced with such uncertainty? The small size of the market makes this more so, exposing our speculator to the risk of having to sell the withheld Maradonas at a big discount, if, say, the chubby bloke is caught smoking pot at the start of the Cup (which actually happened!)

There are many other instances where the presence of high uncertainty affects trade especially in thin markets, forcing traders to trade in small amounts. It is a prediction of inventory models in Finance, and supported by evidence in financial markets. In the poor parts of Africa, trade occurs in ridiculously small amounts; the shopkeeper keeps everything but in small quantities as his poor customers have unpredictable demands, contrary to hypermarkets, which operate in rich countries where demand is more preditable, and can therefore store large amounts.

So, this playground of ours, a microcosm of society, with its sheer variety of little beings, produces a market which is strikingly similar to those with which we are more familiar. This is the amazing thing about markets: they have a brain of their own. Ever played marbles at school? Were you like me, using the rubbish ones at the beginning, leaving the cutest ones for when nearly broke? This is Gresham’s Law at work. And it tells the truth about markets: they may not lead to the best of outcomes.