1. Nate Lorence
10/31/13
Economic History
Paper Introduction and Bibliography
In the 1630 the price of tulips in the Netherlands rose to extraordinary levels. The price
of one rare bulb, on contract, could have been bought for the equivalent of seventeen thousand to
seventy-six thousand of today’s U.S. Dollars (Hirschey 1998). What was the cause of this
massive explosion in the price of tulips? Was it mass hysteria that priced a relatively unexciting
object far above its actual value? Or was it the work of market forces and government laws
regarding contracts that caused this massive increase in price? Could people have acted with
complete rationality when they were bidding the price of a single tulip bulb to almost twice the
income of a median income worker?
This paper will attempt to answer these questions. We will first look at the history of this
event. We will get a little bit of background on circumstances surrounding this time, what the
significance of these tulips was and why they were so important and valuable. We will look at
speculation fears and how they could have driven up the price of tulips and what market
mechanisms were in place to make this happen. We will look at what speculation and “bubbles”
actually are and define them in such a way that it is possible to determine what a “bubble” is and
what is legitimate market forces at work. We will then look at other possible causes for this spike
in price including the government’s enforcement of contract law and how this might have

2. affected the price of the tulips.
The Tulip Mania is thought to be one of the first documented examples of a bubble
in history. It has captured the imagination of many and is often referred to even today as an
example to point to. Recently the former president of the Dutch Central Bank, Nout Wellink
referred to the current valuation of Bitcoins as “worse than the tulip mania” (Hern 2013)
. However in recent years many have questioned the accuracy of calling this a bubble. There
have been several papers that say there were other economic factors that lead to the ballooning
of the price of tulips. Peter M. Garber argues that this enormous price increase is completely in
line with a luxury good item that enters the market with an initially small supply and excessive
demand. And Earl A. Thompson argues that the large increase in price was the result of poorly
enforced futures contracts not market irrationality.
History
Tulips were introduced to the Europe in the late sixteenth century. They came from
Turkey and were unlike any other European flower. Its intense color and rarity made it highly
coveted by the rich. The Netherlands had become a very rich nation through trade and
commerce. These conditions led to the tulip being heavily sought after and expensive. Tulips
were classified by pattern. This meant that some tulips were inherently rarer than others. This
meant that when the “mosaic” virus hit some tulips their prices rose significantly. The mosaic
virus would not kill the tulip but it would cause the colors to break up and make streaks of
different colors on it. These tulips were very rare and hard to grow which made their price
extremely high.

3. Tulips only bloom for a very short time, about a week, in the beginning of May. This
meant that while people engaged in trade year round they only had the actual product for a very
short time. This meant that they had trade in some other way. The tulip bulbs were sold instead
of the actual flowers. This made the trade in tulips almost completely a futures contract market.
During the week or so that the flowers were in bloom there was a spot price market that worked,
but for the other fifty one weeks of the year there was only a futures market. Demand began to
come from other countries and tulip growers in the Netherlands began to increase their stock of
tulip bulbs to meet the increasing demand. This caused the prices for the bulbs to continue to
increase. As the prices marched inevitably upward, speculators were attracted to the market in
order to make a quick profit. Prices skyrocketed as more and more investors entered the market
simply to make a profit. At the peak of the tulip’s price a single bulb of the rarest variety could
go for much as seventy six thousand dollars of today’s dollars, many times the income of a
median worker in that time (Hirschey 1998).. A story from the Harper's New Monthly Magazine
illustrates how inflated the market had become and how this affected the people who were in the
market.
“This gentleman was an amateur botanist, traveling to perfect himself in the
study of his favorite science. Happening to see a large tulip root on a stand in the conservatory
of a wealthy Dutchman, he quietly took out his penknife and began to peel off its coats; for he
too took it for an onion, and wanted to discover of what species it was. After he had peeled off
half its coverings, he cut it in two to inspect the heart. Just at this moment the old gentleman who
owned the conservatory and the bulb turned round to see his precious root cut in two. Seizing the
Englishman by the collar, he shouted out, "Do you know what you are about?" "Certainly; I am
peeling an onion—a most extraordinary onion too." "Extraordinary!" said the Dutchman. "I

4. should think it was. Why, Sir, it is an Admiral Von der Eycke." "Is it?" replied the Englishman,
taking out his pocket-book to note down the name. "And are there many onions of this kind in
your country?" The Dutchman could stand it no longer. He instantly forced the Englishman out
of his grounds, and led him to the syndic, followed by a great crowd. Here the Englishman was
arraigned and tried for stealing and cutting up one tulip worth $1600. The magistrate found the
evidence sufficient (especially as the Englishman admitted that he did take and cut up
something), fined him $1600, and imprisoned him till the fine was paid.” (Hooper 1876)
As the prices went up year after year, more and more bulbs were planted. Eventually
after several years this increased the supply which had put downward pressure on the price. Also
as the prices went up wiser investors started to back out of the market. And as investors tried to
liquidate their assets the bottom started to fall out of the market. This happened so quickly that
within three months the most expensive bulbs had lost ninety percent of their value.
(Thompson 2007 Figure 1 pg 101)

5. As the prices started to fall futures contracts became worse and worse deals. Contracts
made while the prices were extremely high that came to fruition after the crash were not being
honored. Buyers started defaulting on their contracts. Dealers who were holding tulips
complained to the government to step in and enforce the contracts. But the government took a
nonintervention approach to the whole affair. Eventually the complaints were so loud and
numerous that the government had to do something. They said that any contracts made at the
peak of the bubble would be canceled and that the sellers of those contracts could sell them to
the government for ten percent of their value. While this was better than nothing it still left many
who held onto large numbers of tulips over a barrel. They had bought those tulips at a high price,
expecting to be able to sell them for a profit. Most of them had leveraged themselves greatly to
do so. As a result the crash left many merchants bankrupt. The Dutch economy took several
years regain the strength that it enjoyed before the crash.
Alternative Explanations
When you keep in mind that these flowers were a luxury item that were very scarce, an
argument can be made that these flowers were not as ludicrously priced as it seems at first blush.
While these prices are obviously very high there is no indication of what the prices ought to have
been under normal circumstances. What were the factors of supply and demand that went into
creating the price of these tulips?
On the demand side of the equation the fact that this was a luxury item comes into play.
The people who wanted these flowers had a lot of disposable income. They were able to spend
large amounts of money on something that was basically a status symbol. This meant that the

6. ceiling for the price of these tulips was much higher because they did not have to serve and
useful purpose. And since they were luxury goods they would not reach some point where the
price would exceed its usefulness. Because all of its usefulness would come from the utility
gained by the purchaser and not profit that you would hope to gain from a piece of capital. The
fact that the actual flowers were not being sold is very important. Since almost all of the trade
for these bulbs in futures contracts the prices had the ability to go higher. Holland did not have
strong enforcement of futures contracts at this time. (Garber 1990) This meant that buyers could
default on a contract and there would be little or no consequences to this action. The speculators
could invest with impunity knowing that they could easily get out of their contracts if the market
went south. This means that their demand for risky investments was higher than it should have
been.
On the supply side of the equation we also have several contributing factors. One is that
luxury items like this one would start out with a low supply at the beginning which would
drastically increase their prices. This is where Garber makes one of his arguments. He says that
this sort of evaluation is not uncommon in the flower market, even today.
“A standard pricing pattern arises for new varieties of flowers, even in modern markets.
When a particularly prized variety is developed, its original bulb sells for a high price. As the
bulbs accumulate, the variety's price falls rapidly; after less than 30 years, bulbs sell at their
reproduction cost.” (Garber 1990)
When a rare bulb initially comes into the market, the supply is very low and the demand
is very high. Suppliers cannot plant enough bulbs to keep up with demand; consequently the
price for the bulbs is very high. However, since the price is so high, this gives incentive for more

7. and more people to enter the market to gain some of the economic profits. This additional supply
causes the price to drop to the cost it would take to grow them. Bulbs such as the ones with the
mosaic virus were very hard to come by since it was very hard to breed them. This meant that
they were even rarer than other tulips bulbs of that time. This could be what pushed the price for
the rarest breeds of bulb to astronomical levels.
Another supply related concern for the tulip dealers once the planting season for the
tulips was over they could not plant anymore. Dealers could not respond to increases in price by
adding more supply. Once the planting season was over they could not increase supply until the
following year. The supply was completely fixed this lead to skyrocketing prices. The supply
side of the market was completely inelastic for all but a couple weeks a year. If a product as a
fixed supply while the demand is growing it is almost guaranteed that you will get a sharp
increase in price. This is not necessarily an indicator of irrational behavior.
The luxury nature of this good combined with the futures contracts that not default safe
and the fixed nature of supply of flowers could have combined to create this large increase in
price. If a good is very scarce and limited but rich people with a lot of disposable income are the
ones bidding for it you have the perfect conditions for a skyrocketing of the price.
Bubbles
In order to determine the validity of calling the rise in tulip prices a bubble it would be
helpful to discuss what a bubble is. There are many different definitions so it must be defined
what is meant by the term bubble. Is a bubble simply a period of time in which a commodity is

8. very highly valued after which it loses most of that value? Do they, as Thompson puts it,
“require the existence of mutually-agreed-upon prices that exceed fundamental values.”? While
this is an important feature that is not all there is to it. You cannot simply define a bubble as
prices that exceed fundamental values. If this is all there was to it then minimum wage workers
could be defined as a bubble. You must also include some acknowledgment of the sociological
aspect that is necessary in a bubble situation.
Investors are not buying stock in a bubble because they think it is stable and a good
commodity to invest in. They are buying because they know that the price is going up regardless
of that actual commodity. They would like to sell the commodity because the price is going up as
more and more people want to entire the market and not because of an increase in utility of the
object. Think of a game of hot potato crossed with a Ponzi scheme. Everyone is trying to extract
some value and pass the buck to the next person before the crash. And when the crash happens
the last person is stuck paying for all the wealth that everyone else extracted. Many definitions
will only reference one aspect of a bubble. They will reference the rising and falling of prices.
Or they will reference the valuation greater than that of intrinsic value. A definition is need that
includes all of these aspects. The definition for an economic bubble that will be used for this
paper is
“A sociological and psychological phenomenon whose catalyst is price movements.
Price increases cause a domino effect that causes the price to spiral upward, far above the actual
market price of the good. After a period time, with no actual value to support the high price of
the good, the price will quickly fall back down to market price.”

9. So the main driving force behind the price increase in a bubble is the price increase its
self. If there are other factors that are causing the price to rise then that should not be considered
a bubble as the demand that is raising the price is coming from a legitimate source and not
irrational exuberance about the prospects of the commodity.
Speculation v. Futures
While many say that speculation is the reason for the catastrophic increase in
prices we must look at the market conditions and the decision calculus that goes went into
deciding how much to bid for the tulips. The evidence clearly seems to point a speculative
bubble. However this graph shows all available price point data, if you look a graph that has spot
and futures prices separated from the unexercised strike prices the data tells a much different
story.
(Thompson 2007 Figure 2 pg 102)

10. This graph tells a much different story than the one that the first figure implies. This
graph says that there never actually was a bubble. While the real price of the tulips stays low the
unexercised strike price skyrocketed. What can explain the massive disparity of these two lines?
Thompson believes that the difference can be explained by the government in that year. They
said that all contracts written November 30 1636 and the reopening of the spot market in the
spring would include a new provision. This provision said that buyers of the contract were
absolved of the responsibility to buy the tulips at the price agreed upon in the contract. But
instead they could fulfill the contract by paying the seller a small percentage of the contracted
price. What this essentially did was convert these futures contracts into call option contracts.
(Thompson 2007)
This absolved the buyer from nearly all responsibility to pay for the tulip bulbs that he
committed to purchase. With this incentive of an enforced contract gone there was nothing to
stop these contracts from being bid up to ludicrous levels. Because they were now not futures
contracts, they were call options.
You might ask why such a change was made. Thompson explains it in his paper.
“Some of these heavily margined speculative buyers were having their livelihoods
threatened at the expense of professional tulip planters, who had already become rich during
the extended upturn. So it should be no surprise that the public officials quickly met with the
concerned public after the crash in order to discuss the "problem." The above-described contract
conversion was natural to them. After all, the more knowledgeable planters - who probably
immediately understood the effect of Wittstock and even hyped the sale of tulip futures in mid-
October in order to liquidate their dealer inventories at favorable prices could afford it. As the

11. information of the public officials' deliberations and plans entered the market in late November,
contract prices soared to reflect the expectation that the contract price was now a call-option
exercise, or strike, price rather than a price committed to be paid for future bulbs.”
(Johnson 2007)
Conclusions
While at first glance it might seem as though the high prices of tulips, in Holland, in the
sixteen thirties, were caused by wild speculation. The price of a commodity had a massive surge
and then crashed all within the span of a couple of months. But if we look closer at the actual
market forces at work during this time that conclusion is not so obvious. First of all in order for a
bubble to occur the price must be out of line with the true market value of the good. It is not so
obvious that that is the case in this scenario. Newly introduced flowers normally went for very
high prices when they were first brought into a market. Only after the supply had been given a
chance to stabilize would the prices come down. And tulips were a very special case in the first
place. They had the mosaic virus that made certain tulips even rarer than a normal tulip already
was.
The supply side of the market was very inelastic. Once the bulbs had been planted for the
year there was no opportunity to plant more if the prices rose. When the supply has no
opportunity increase in response to a growing demand and rising price, the price is going to rise
far more than it would have otherwise. You cannot automatically look a high price and assume
that there is a bubble.

12. The most important reason why calling Tulipmania a bubble is erroneous, is the way the
Dutch changed futures contracts. This exacerbated the skyrocketing price. While they are
similar, in this case a futures contract leads to a very different outcome from a call option.
People would not have been so eager to bid the prices so far up if they had been responsible for
the entire contract when it came to fruition. But in the end they were just bidding up the price
hoping to make a little bit of money just in case the prices went higher than what they had paid
for it.
In the end though Tulipmania is pointed to as the first great example of an economic
bubble where people lost their collective minds and went along with the mob. All the evidence
that we have suggests that the Dutch merchants were acting rationally and the exorbitantly high
price for tulips was the correct price.

13. Bibliography
1. How Much Is a Tulip Worth? Author(s): Mark Hirschey Source: Financial Analysts
Journal, Vol. 54, No. 4 (Jul. - Aug., 1998), pp. 11-17 Published by: CFA Institute Stable
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2. The Tulipmania: Fact or Artifact? Author(s): Earl A. Thompson Source: Public Choice ,
Vol. 130, No. 1/2 (Jan., 2007), pp. 99-114 Published by: Springer Article Stable URL:
http://www.jstor.org/stable/27698044
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The Quarterly Journal of Austrian Economics, Spring 2006, 9(1), pp. 3-14. Updated 1/
15/2007 Published by: The Ludwig Von Mises Institute Stable URL: http://mises.org/
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Perspectives, Vol. 4, No. 2 (Spring, 1990), pp. 35-54 Published by: American Economic
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5. The Tulip Mania Author(s): William R. Hooper Source: Harper's New Monthly
Magazine. No. CCCXL, April 1876, Vol. LII. Published by: WikiSource Stable URL:
http://en.wikisource.org/wiki/The_Tulip_Mania
6. "Bitcoin Hype Worse than 'Tulip Mania', Says Dutch Central Banker." Authors: Hern,
Alex. Theguardian.com. Guardian News and Media, 04 Dec. 2013. Web. 04 Dec. 2013.
http://www.theguardian.com/technology/2013/dec/04/bitcoin-bubble-tulip-dutch-banker
7. Tulipmania Author(s): Peter M. Garber Source: Journal of Political Economy, Vol.
97, No. 3 (Jun., 1989), pp. 535-560 Published by: The University of Chicago http://
www.jstor.org/stable/1830454
8.