The Economics of The Economics of Professional Professional

SportsSportsSharp, Register and Grimes Sharp, Register and Grimes

Chapter 9Chapter 9

What is the most subsidized What is the most subsidized industry in all of America?industry in all of America?

““From 1990 to 2000, 10 new NFL stadiums From 1990 to 2000, 10 new NFL stadiums opened at a total cost of $2.677 billion (in opened at a total cost of $2.677 billion (in inflation-adjusted 2000 estimated dollars), inflation-adjusted 2000 estimated dollars), with taxpayers financing 77%, or $2.057 with taxpayers financing 77%, or $2.057 billion dollars. And these numbers do not billion dollars. And these numbers do not include tens of millions of dollars more in include tens of millions of dollars more in stadium renovations. During the 2001 and stadium renovations. During the 2001 and 2002 seasons, an estimated $2.1 billion will 2002 seasons, an estimated $2.1 billion will be spent on six new NFL stadiums, with be spent on six new NFL stadiums, with taxpayers picking up about $1.2 billion, or taxpayers picking up about $1.2 billion, or 57% of the costs.”57% of the costs.”

Question 1Question 1

What does it mean for an industry to What does it mean for an industry to be subsidized?be subsidized?

In what kind of market structure are In what kind of market structure are industries subsidized? Perfect industries subsidized? Perfect competition? Explain.competition? Explain.

The Professional Sports The Professional Sports BusinessBusiness

Multibillion-dollar business that Multibillion-dollar business that provides entertainment to millions of provides entertainment to millions of fans each yearfans each year

Unlike most other business in two Unlike most other business in two ways:ways:

1.1. The organizational structure of the The organizational structure of the professional team sports industryprofessional team sports industry

2.2. The unique relationship between the The unique relationship between the sports clubs and the playerssports clubs and the players

Organizational StructureOrganizational Structure

Individual teams or clubs are owned Individual teams or clubs are owned and operated for profit by private and operated for profit by private individuals or partnershipsindividuals or partnerships

Team owners are entrepreneurs who Team owners are entrepreneurs who hire and fire the managers, coaches, hire and fire the managers, coaches, and players; rent or build the and players; rent or build the stadium; and sell the tickets and stadium; and sell the tickets and broadcast rights to games. broadcast rights to games.

The Role of CompetitionThe Role of Competition

Sprts clubs cannot operate Sprts clubs cannot operate independently but must cooperate independently but must cooperate with one another in order to sell their with one another in order to sell their entertainment services to the publicentertainment services to the public

Question 2:Question 2:

What does it mean for firms to cooperate What does it mean for firms to cooperate with each other?with each other?

Is this different than any market structure we Is this different than any market structure we have seen before?have seen before?

Do firms usually cooperate with each other?Do firms usually cooperate with each other? Can you imagine if this is a good or bad thing Can you imagine if this is a good or bad thing

generally? What if Honda, Subaru, and generally? What if Honda, Subaru, and Toyota cooperated with each other? What Toyota cooperated with each other? What would be the outcome for consumers?would be the outcome for consumers?

Sports Leagues: Sports Leagues: formal organizations of individual formal organizations of individual

clubsclubs American League/National American League/National

League/Major League BaseballLeague/Major League Baseball National Basketball AssociationNational Basketball Association National Football AssociationNational Football Association National Hockey LeagueNational Hockey League

What is the role of the league?What is the role of the league?

Teams that are members of a Teams that are members of a professional sports league are professional sports league are contractually obligated to one another.contractually obligated to one another.

The league determines: the schedule of The league determines: the schedule of games; makes and enforces game games; makes and enforces game rules; sets the guidelines for hiring new rules; sets the guidelines for hiring new players; determines when a new team players; determines when a new team will be admitted to the league and will be admitted to the league and allowed to compete with its membersallowed to compete with its members

Teams and PlayersTeams and Players

Unique relationshipUnique relationship Productivity is visible and easily Productivity is visible and easily

measuredmeasured

Question 3Question 3

What is productivity?What is productivity? What is the ‘usual’ relationship What is the ‘usual’ relationship

between productivity and a worker’s between productivity and a worker’s wages?wages?

Is this relationship the same for Is this relationship the same for professional sport players?professional sport players?

Professional Sport Salaries: Professional Sport Salaries: Whoa!Whoa!

Huge salariesHuge salaries Large differences in salaries between Large differences in salaries between

playersplayers Rules imposed by each of the major Rules imposed by each of the major

sports leagues to promote sports leagues to promote competition on the playing field competition on the playing field contribute to the seemingly contribute to the seemingly inconsistent economics of players’ inconsistent economics of players’ salariessalaries

Choosing a player/choosing a Choosing a player/choosing a clubclub

Question: How will you decide what Question: How will you decide what company to work for?company to work for?

Question: How does a professional Question: How does a professional sports player decide which team to sports player decide which team to play for?play for?

How are these decisions different?How are these decisions different? Should they be different? Why?Should they be different? Why?

Competition and employmentCompetition and employment Competition on the field would diminish if Competition on the field would diminish if

any club had the ability to hoard the best any club had the ability to hoard the best athletic talent.athletic talent.

League rules are designed to ensure that League rules are designed to ensure that each club has the opportunity to employ each club has the opportunity to employ and retain quality playersand retain quality players

Leagues establish the procedures whereby Leagues establish the procedures whereby member clubs acquire the “property rights” member clubs acquire the “property rights” to contract with specific players.to contract with specific players.

Because specific clubs may hold the Because specific clubs may hold the exclusive right to contract with a player, exclusive right to contract with a player, athletes are not always free to work for the athletes are not always free to work for the highest bidder.highest bidder.

Imperfect MarketsImperfect Markets

Question: How has the behavior of the Question: How has the behavior of the professional sports clubs that we’ve professional sports clubs that we’ve been discussion compared to the been discussion compared to the types of firms we discussed under the types of firms we discussed under the perfect competition scenario?perfect competition scenario?

Are professional sports clubs Are professional sports clubs competitive with each other? Why or competitive with each other? Why or why not?why not?

What would happen if they were What would happen if they were perfectly competitive?perfectly competitive?

More on Imperfect MarketsMore on Imperfect Markets

Imperfect Product Market: when Imperfect Product Market: when buyers and sellers engage in the buyers and sellers engage in the exchange of final goods and servicesexchange of final goods and services

Imperfect Resource Market: when Imperfect Resource Market: when buyers and sellers engage in the buyers and sellers engage in the exchange of factors of production – exchange of factors of production – like capital and laborlike capital and labor

The Product MarketThe Product Market

The essence of sports is competitionThe essence of sports is competition Essential for the professional sports Essential for the professional sports

clubs for this competition to be in the clubs for this competition to be in the playing field and not in the playing field and not in the marketplacemarketplace

Why?Why?

What if sports clubs competed in What if sports clubs competed in perfectly competitive markets?perfectly competitive markets?

More successful clubs would sell more tickets More successful clubs would sell more tickets and team merchandiseand team merchandise

Earn higher profitsEarn higher profits Have the ability to attract the best players Have the ability to attract the best players

with higher salarieswith higher salaries Over time, these clubs would become so much Over time, these clubs would become so much

stronger than the less successful teams that stronger than the less successful teams that competition on the playing field would competition on the playing field would deteriorate and become boring for spectatorsdeteriorate and become boring for spectators

If spectators don’t come, then everyone If spectators don’t come, then everyone loses…loses…

If you build it, they will come…If you build it, they will come…

To remain in business and earn To remain in business and earn profits for their owners, professional profits for their owners, professional sports clubs must avoid the above sports clubs must avoid the above scenario. How?scenario. How?

Coordination of economic decisions Coordination of economic decisions through league rules and guildelines.through league rules and guildelines.

Question: What is a Cartel?Question: What is a Cartel?

Are professional sports leagues like Are professional sports leagues like cartels?cartels?

If so, why are cartels o.k. in this If so, why are cartels o.k. in this situation and not in others?situation and not in others?

Cartel: DefinitionCartel: Definition

A group of firms that formally agree A group of firms that formally agree to coordinate their production and to coordinate their production and pricing decisions in a manner that pricing decisions in a manner that maximizes joint profitsmaximizes joint profits

A cartel can be viewed as a group of A cartel can be viewed as a group of firms behaving as if they were one firms behaving as if they were one firm—a shared monopolyfirm—a shared monopoly

What if…What if…

What if Toyota, Honda, and Subaru What if Toyota, Honda, and Subaru created a cartel?created a cartel?

How is this different (or is it?) than How is this different (or is it?) than professional sports leagues?professional sports leagues?

Antitrust laws…Antitrust laws…

Antitrust laws make it illegal, in most Antitrust laws make it illegal, in most cases, for firms to monopolize an cases, for firms to monopolize an industry through the formation of a industry through the formation of a cartelcartel

Why?Why? 1922, the U.S. Supreme Court ruled 1922, the U.S. Supreme Court ruled

that major league baseball did not that major league baseball did not meet the legal definition of interstate meet the legal definition of interstate commerce and was therefore not commerce and was therefore not subject to the restrictions of antitrust.subject to the restrictions of antitrust.

For a cartel to be successful it For a cartel to be successful it needs:needs:

First: The cartel members must be First: The cartel members must be responsible for most of the output responsible for most of the output produced in their marketproduced in their market

(the greater the proportion of total (the greater the proportion of total market output generated by the cartel market output generated by the cartel members as a group, the greater the members as a group, the greater the cartel’s degree of monopoly power)cartel’s degree of monopoly power)

Why would this be true?Why would this be true? What is “monopoly power”What is “monopoly power”

Monopoly PowerMonopoly Power

The degree to which a firm (or firms The degree to which a firm (or firms in the case of a cartel) can be a in the case of a cartel) can be a “price maker”“price maker”

This translates directly into the This translates directly into the amount of profits a firm (or firms) amount of profits a firm (or firms) can get in an industrycan get in an industry

In general, the more monopoly In general, the more monopoly power, the higher the profitspower, the higher the profits

So how does the cartel work?So how does the cartel work?

Basically firms coordinate their Basically firms coordinate their behavior in order to act like a behavior in order to act like a monopoly…limit Q and increase P… monopoly…limit Q and increase P… then split the high profits.then split the high profits.

If they competed, their prices would If they competed, their prices would fall and corresponding profits would fall and corresponding profits would fallfall

So, its in their best interest to So, its in their best interest to coordinatecoordinate

More requirements for cartels…More requirements for cartels…

Second: The cartel must be able to prevent Second: The cartel must be able to prevent new competitors from entering the market, or new competitors from entering the market, or be able to integrate new competitors into the be able to integrate new competitors into the cartelcartel

How do the major sports leagues do this? Do How do the major sports leagues do this? Do you know an example when they have you know an example when they have eliminated competition? Controlled contracts eliminated competition? Controlled contracts of star players? Restricted the ability to start of star players? Restricted the ability to start new rival leagues to compete for fan’s new rival leagues to compete for fan’s attention?attention?

More requirements for cartelsMore requirements for cartels

Third: cartel members must produce Third: cartel members must produce fairly homogeneous outputsfairly homogeneous outputs

Why? Why would producing the same Why? Why would producing the same or similar goods enhance or similar goods enhance coordination between the clubs? Or coordination between the clubs? Or between coordinating firms?between coordinating firms?

More more more!More more more!

Cartels must be able to divide the Cartels must be able to divide the market into territories controlled by market into territories controlled by each member and to establish each member and to establish production quotasproduction quotas

Cartel members must agree on how Cartel members must agree on how their combined monopoly power will their combined monopoly power will be shared among themselvesbe shared among themselves

How do professional sports clubs do How do professional sports clubs do this?this?

More…More…

Fifth: a cartel must have the power to Fifth: a cartel must have the power to prevent “cheating” by other members.prevent “cheating” by other members.

In many cartel situations, an incentive to In many cartel situations, an incentive to cheat on the agreement exists for member cheat on the agreement exists for member firms…firms…

Some firms may find it profitable to break Some firms may find it profitable to break production quotas or enter another production quotas or enter another member’s sales territory in an effort to member’s sales territory in an effort to capture more than the agreed upon share capture more than the agreed upon share of the monopolyof the monopoly

The Tragedy of the Commons: The Tragedy of the Commons: A Cartel ParableA Cartel Parable

Firms in a cartel have an incentive to Firms in a cartel have an incentive to cheatcheat

This whittles away at the profitsThis whittles away at the profits

Unless the cartel is formed in a legally Unless the cartel is formed in a legally sanctioned way, there is no way to sanctioned way, there is no way to police the cheatingpolice the cheating

Coordinating BehaviorCoordinating Behavior

Joint marketing and revenue sharingJoint marketing and revenue sharing Revenue comes from three major Revenue comes from three major

sources: ticket and concession sales, sources: ticket and concession sales, merchandising rights for team merchandising rights for team souvenirs and novelties, and radio souvenirs and novelties, and radio and tv broadcasting rightsand tv broadcasting rights

Each league has specific rules for Each league has specific rules for dividing the revenue generated dividing the revenue generated through ticket sales between a host through ticket sales between a host team and the visiting teamteam and the visiting team

Pricing and Output for Broadcast Pricing and Output for Broadcast RightsRights

Leagues have been most successful in Leagues have been most successful in jointly selling their entertainment jointly selling their entertainment servicesservices

Each league sells the national tv and Each league sells the national tv and radio broadcast rights to all the games radio broadcast rights to all the games played by its members as “package played by its members as “package deals” to the highest bidderdeals” to the highest bidder

Revenue is then divided among the Revenue is then divided among the member clubs see table 9.1 and figure member clubs see table 9.1 and figure 9.19.1

The Number and Location of The Number and Location of TeamsTeams

Incentive to restrict the number of Incentive to restrict the number of new membersnew members

Why?Why? Creates an incentive to relocate to Creates an incentive to relocate to

new marketsnew markets Shortage of teams?Shortage of teams?

The Stadium ControversyThe Stadium Controversy

Billions of local tax dollars spent on Billions of local tax dollars spent on the construction of new stadiums and the construction of new stadiums and sports arenassports arenas

$4 out of every $5 spent came from $4 out of every $5 spent came from public sources public sources

Why?Why?

The Resource MarketThe Resource Market

The employment of playersThe employment of players Monopsony: a market with only one Monopsony: a market with only one

buyer or one employerbuyer or one employer

Why monopsony?Why monopsony?

Players legally locked into their Players legally locked into their drafted positiondrafted position

Highly and specifically skilledHighly and specifically skilled Players have little bargaining powerPlayers have little bargaining power Free AgencyFree Agency Labor UnionsLabor Unions

Do professional athletes earn their Do professional athletes earn their pay?pay?

QuestionsQuestions

Explain why professional sports teams Explain why professional sports teams must cooperate with one another in order must cooperate with one another in order to produce competitive games for fans.to produce competitive games for fans.

What is a cartel? What industry What is a cartel? What industry characteristics are necessary for the characteristics are necessary for the successful formation and operation of a successful formation and operation of a cartel?cartel?

Professional baseball enjoys a special legal Professional baseball enjoys a special legal exemption in the US. What is this exemption in the US. What is this exemption, and why does it exist? Does it exemption, and why does it exist? Does it apply to other sports leagues?apply to other sports leagues?

More QuestionsMore Questions Explain how professional sports leagues maximize Explain how professional sports leagues maximize

joint profits through coordinated behavior in the joint profits through coordinated behavior in the product market. Will each team earn the same product market. Will each team earn the same amount of profit under a cartel agreement as it amount of profit under a cartel agreement as it would if market competition prevailed?would if market competition prevailed?

Why does a cartel’s marginal revenue curve lie Why does a cartel’s marginal revenue curve lie below its demand curve? Explain with a numerical below its demand curve? Explain with a numerical example and a graph.example and a graph.

Why do taxpayers continue to support the public Why do taxpayers continue to support the public financing of new stadiums and arenas for financing of new stadiums and arenas for professional sports teams? Are new stadiums and professional sports teams? Are new stadiums and arenas good investments for a metropolitan area? arenas good investments for a metropolitan area? Why or why not?Why or why not?

Even More Questions!Even More Questions!

Discuss the economic pressures and Discuss the economic pressures and incentives for professional sports teams to incentives for professional sports teams to relocate. Are professional sports teams an relocate. Are professional sports teams an important tool for a city’s economic important tool for a city’s economic development? Why or why not?development? Why or why not?

What is a monopsony? What conditions give What is a monopsony? What conditions give rise to a monopsony:? How can professional rise to a monopsony:? How can professional sports teams be considered monopsonies?sports teams be considered monopsonies?

What is free agency? How has it eroded the What is free agency? How has it eroded the monopsonistic power of professional team monopsonistic power of professional team sports?sports?

More Questions!More Questions! For many years professional football players have For many years professional football players have

earned on average less than half of what earned on average less than half of what professional baseball players earn. Using professional baseball players earn. Using economic reasoning, how can this fact be economic reasoning, how can this fact be explained?explained?

Why do team owners rigorously regulate the Why do team owners rigorously regulate the number of teams in their league? Under what number of teams in their league? Under what circumstances would team owners vote for an circumstances would team owners vote for an expansion in the number of teams? When would expansion in the number of teams? When would they vote for a reduction of the number of teams?they vote for a reduction of the number of teams?

Are professional sports players worth their Are professional sports players worth their multimillion dollar salaries? Explain.multimillion dollar salaries? Explain.