I think armor should be taken out of the "sell" economy and placed firmly in the 'buy" economy.
If you fight someone, and lest say they have a full set of armor, then there should only be a 20% chance that at the end of a fight that any or the armor is actually salvageable. It might take fighting ten people with Orcish armor to even get half the pieces you need. The economy should be that armor is typically half acquired and have bought. You might get most of the armor via drops eventually but in some cases, it should be just easier to BUY one or two pieces you do not have. Moreover, since armor drops are very rare people cannot just 'farm' dungeons for armor to sell. As I said above take the ability to profit from grabbing and selling armor and lower it until it is not the most profitable thing to be doing.
If you want to kill people and have them drop maybe 1 item, perhaps you should be playing a game like Diablo. Or WoW.
One of the things I've always like about the TES series was that enemies actually had the gear on them, that they were using. It's a defining aspect of the series for me. Having rare random drops off hordes of "farmed" mobs is for those other hack-n-slash RPGs - not TES.
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I also notice a number of people in this thread who don't believe in "progression" - gaining in power at a reasonable rate (matched to the increase in difficulty), rather than finding Uber Sword or Armor off some level 2 dude at the beginning of the game and then having an unfair advantage over the game until it's difficulty catches up with your "rare drop".
If you can get great stuff right at the beginning, how can you improve from there?
I want to improve my gear over time, not just "win the lottery" and get it handed to me at the start.
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disclaimer - I've always played Oblivion with a scaling mod, which meant that some of the things that people mention in this thread (like enemies wearing mixed-quality gear, and high level bandits not having much glass/daedric/etc) is how it's been. But making high-level gear into super-rare-heirloom, only one in the game..... meh, doesn't sound interesting.