The Economics of Professional Sports

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The Economics of Professional Sports

• Sharp, Register and Grimes Chapter 9

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What is the most subsidized industry in all of
America?

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

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Question 1

• What does it mean for an industry to be
  subsidized?
• In what kind of market structure are industries
  subsidized? Perfect competition? Explain.

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The Professional Sports Business

• Multibillion-dollar business that provides
  entertainment to millions of fans each year
• Unlike most other business in two ways
• The organizational structure of the professional
  team sports industry
• The unique relationship between the sports clubs
  and the players

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Organizational Structure

• Individual teams or clubs are owned and operated
  for profit by private individuals or partnerships
• Team owners are entrepreneurs who hire and fire
  the managers, coaches, and players rent or build
  the stadium and sell the tickets and broadcast
  rights to games.

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The Role of Competition

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

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Question 2

• What does it mean for firms to cooperate with
  each other?
• Is this different than any market structure we
  have seen before?
• Do firms usually cooperate with each other?
• Can you imagine if this is a good or bad thing
  generally? What if Honda, Subaru, and Toyota
  cooperated with each other? What would be the
  outcome for consumers?

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Sports Leagues formal organizations of
individual clubs

• American League/National League/Major League
  Baseball
• National Basketball Association
• National Football Association
• National Hockey League

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What is the role of the league?

• Teams that are members of a professional sports
  league are contractually obligated to one
  another.
• The league determines the schedule of games
  makes and enforces game rules sets the
  guidelines for hiring new players determines
  when a new team will be admitted to the league
  and allowed to compete with its members

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Teams and Players

• Unique relationship
• Productivity is visible and easily measured

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Question 3

• What is productivity?
• What is the usual relationship between
  productivity and a workers wages?
• Is this relationship the same for professional
  sport players?

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Professional Sport Salaries Whoa!

• Huge salaries
• Large differences in salaries between players
• Rules imposed by each of the major sports leagues
  to promote competition on the playing field
  contribute to the seemingly inconsistent
  economics of players salaries

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Choosing a player/choosing a club

• Question How will you decide what company to
  work for?
• Question How does a professional sports player
  decide which team to play for?
• How are these decisions different?
• Should they be different? Why?

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Competition and employment

• Competition on the field would diminish if any
  club had the ability to hoard the best athletic
  talent.
• League rules are designed to ensure that each
  club has the opportunity to employ and retain
  quality players
• Leagues establish the procedures whereby member
  clubs acquire the property rights to contract
  with specific players.
• Because specific clubs may hold the exclusive
  right to contract with a player, athletes are not
  always free to work for the highest bidder.

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Imperfect Markets

• Question How has the behavior of the
  professional sports clubs that weve been
  discussion compared to the types of firms we
  discussed under the perfect competition scenario?
• Are professional sports clubs competitive with
  each other? Why or why not?
• What would happen if they were perfectly
  competitive?

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More on Imperfect Markets

• Imperfect Product Market when buyers and sellers
  engage in the exchange of final goods and
  services
• Imperfect Resource Market when buyers and
  sellers engage in the exchange of factors of
  production like capital and labor

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The Product Market

• The essence of sports is competition
• Essential for the professional sports clubs for
  this competition to be in the playing field and
  not in the marketplace
• Why?

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What if sports clubs competed in perfectly
competitive markets?

• More successful clubs would sell more tickets and
  team merchandise
• Earn higher profits
• Have the ability to attract the best players with
  higher salaries
• Over time, these clubs would become so much
  stronger than the less successful teams that
  competition on the playing field would
  deteriorate and become boring for spectators
• If spectators dont come, then everyone loses

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If you build it, they will come

• To remain in business and earn profits for their
  owners, professional sports clubs must avoid the
  above scenario. How?
• Coordination of economic decisions through league
  rules and guildelines.

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Question What is a Cartel?

• Are professional sports leagues like cartels?
• If so, why are cartels o.k. in this situation and
  not in others?

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Cartel Definition

• A group of firms that formally agree to
  coordinate their production and pricing decisions
  in a manner that maximizes joint profits
• A cartel can be viewed as a group of firms
  behaving as if they were one firma shared
  monopoly

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What if

• What if Toyota, Honda, and Subaru created a
  cartel?
• How is this different (or is it?) than
  professional sports leagues?

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Antitrust laws

• Antitrust laws make it illegal, in most cases,
  for firms to monopolize an industry through the
  formation of a cartel
• Why?
• 1922, the U.S. Supreme Court ruled that major
  league baseball did not meet the legal definition
  of interstate commerce and was therefore not
  subject to the restrictions of antitrust.

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For a cartel to be successful it needs

• First The cartel members must be responsible for
  most of the output produced in their market
• (the greater the proportion of total market
  output generated by the cartel members as a
  group, the greater the cartels degree of
  monopoly power)
• Why would this be true?
• What is monopoly power

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Monopoly Power

• The degree to which a firm (or firms in the case
  of a cartel) can be a price maker
• This translates directly into the amount of
  profits a firm (or firms) can get in an industry
• In general, the more monopoly power, the higher
  the profits

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So how does the cartel work?

• Basically firms coordinate their behavior in
  order to act like a monopolylimit Q and increase
  P then split the high profits.
• If they competed, their prices would fall and
  corresponding profits would fall
• So, its in their best interest to coordinate

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More requirements for cartels

• Second The cartel must be able to prevent new
  competitors from entering the market, or be able
  to integrate new competitors into the cartel
• How do the major sports leagues do this? Do you
  know an example when they have eliminated
  competition? Controlled contracts of star
  players? Restricted the ability to start new
  rival leagues to compete for fans attention?

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More requirements for cartels

• Third cartel members must produce fairly
  homogeneous outputs
• Why? Why would producing the same or similar
  goods enhance coordination between the clubs? Or
  between coordinating firms?

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More more more!

• Cartels must be able to divide the market into
  territories controlled by each member and to
  establish production quotas
• Cartel members must agree on how their combined
  monopoly power will be shared among themselves
• How do professional sports clubs do this?

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More

• Fifth a cartel must have the power to prevent
  cheating by other members.
• In many cartel situations, an incentive to cheat
  on the agreement exists for member firms
• Some firms may find it profitable to break
  production quotas or enter another members sales
  territory in an effort to capture more than the
  agreed upon share of the monopoly

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The Tragedy of the Commons A Cartel Parable

• Firms in a cartel have an incentive to cheat
• This whittles away at the profits
• Unless the cartel is formed in a legally
  sanctioned way, there is no way to police the
  cheating

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Coordinating Behavior

• Joint marketing and revenue sharing
• Revenue comes from three major sources ticket
  and concession sales, merchandising rights for
  team souvenirs and novelties, and radio and tv
  broadcasting rights
• Each league has specific rules for dividing the
  revenue generated through ticket sales between a
  host team and the visiting team

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Pricing and Output for Broadcast Rights

• Leagues have been most successful in jointly
  selling their entertainment services
• Each league sells the national tv and radio
  broadcast rights to all the games played by its
  members as package deals to the highest bidder
• Revenue is then divided among the member clubs
  see table 9.1 and figure 9.1

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The Number and Location of Teams

• Incentive to restrict the number of new members
• Why?
• Creates an incentive to relocate to new markets
• Shortage of teams?

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The Stadium Controversy

• Billions of local tax dollars spent on the
  construction of new stadiums and sports arenas
• 4 out of every 5 spent came from public sources
  
• Why?

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The Resource Market

• The employment of players
• Monopsony a market with only one buyer or one
  employer

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Why monopsony?

• Players legally locked into their drafted
  position
• Highly and specifically skilled
• Players have little bargaining power
• Free Agency
• Labor Unions

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Do professional athletes earn their pay?
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Questions

• Explain why professional sports teams must
  cooperate with one another in order to produce
  competitive games for fans.
• What is a cartel? What industry characteristics
  are necessary for the successful formation and
  operation of a cartel?
• Professional baseball enjoys a special legal
  exemption in the US. What is this exemption, and
  why does it exist? Does it apply to other sports
  leagues?

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More Questions

• Explain how professional sports leagues maximize
  joint profits through coordinated behavior in the
  product market. Will each team earn the same
  amount of profit under a cartel agreement as it
  would if market competition prevailed?
• Why does a cartels marginal revenue curve lie
  below its demand curve? Explain with a numerical
  example and a graph.
• Why do taxpayers continue to support the public
  financing of new stadiums and arenas for
  professional sports teams? Are new stadiums and
  arenas good investments for a metropolitan area?
  Why or why not?

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Even More Questions!

• Discuss the economic pressures and incentives for
  professional sports teams to relocate. Are
  professional sports teams an important tool for a
  citys economic development? Why or why not?
• What is a monopsony? What conditions give rise to
  a monopsony? How can professional sports teams
  be considered monopsonies?
• What is free agency? How has it eroded the
  monopsonistic power of professional team sports?

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More Questions!

• For many years professional football players have
  earned on average less than half of what
  professional baseball players earn. Using
  economic reasoning, how can this fact be
  explained?
• Why do team owners rigorously regulate the number
  of teams in their league? Under what
  circumstances would team owners vote for an
  expansion in the number of teams? When would they
  vote for a reduction of the number of teams?
• Are professional sports players worth their
  multimillion dollar salaries? Explain.