Labor Supply

1
Labor Supply

• The decision to work can be examined from two
  perspectives
• The opportunity cost of work. If one does not
  work one forfeits the wage the worker would be
  paid.
• Substitution effect ?H/?W Y constant gt 0
• Where H Hours Worked
• W Wage Paid
• Y Income
• Example A reduction in social security tax to
  offset an increase in another tax. This would
  encourage more work.
• Wealth or income effect
• Income effect ?H/?Y W constant lt 0
• Example An inheritance
• Implications of these two opposing forces The
  backward bending supply curve.
• Implications for sports Athletes and coaches
  frequently retire before their abilities are
  completely exhausted.

2
The Firms Input Choice in the Short Run

• Fundamental assumption Firms seek to maximize
  profits.
• How does a firm accomplish this objective? If we
  assume perfectly competitive output and input
  markets then a firm cannot
• change the price of its output.
• change the price of its inputs.
• A firm can change the quantity of output produced
  and inputs hired.
• Firms maximize profits be equating marginal
  revenue and marginal cost.
• With respect to inputs, firms will add inputs as
  long as the income generated by the input exceeds
  the expense of the input.

3
Marginal Income vs. Marginal Expense

• How do we measure the marginal income from an
  additional input?
• The value of a worker can be divided into two
  parts
• Marginal Product of Labor the productivity of
  the last unit of labor hired (i.e. the
  productivity of a worker).
• Marginal Revenue of Output the revenue generated
  by the last unit sold (i.e. the value of a unit
  produced).
• Marginal Revenue Product MP MR
• Note In perfect competition, price equals
  marginal revenue. In that case we measure the
• Value Marginal Product MP Price of Output
• How do we measure the marginal expense of an
  additional input?
• In a perfectly competitive labor market, the
  marginal expense of labor is the wage.
• To maximize profits, the firm will equate the
  workers MRP and Wage.

4
The Law of Diminishing Returns and Profit
Maximizing Hiring

• Law of Diminishing Returns - As the amount of a
  variable input is increased, holding all else
  constant, the rate of increase in output will
  eventually decline.
• Implications As a firm expands the size of its
  labor force, the productivity of each additional
  worker declines. In other words, marginal
  product (and MRP) decline as the number of
  workers increases.
• If wages are set by the market, how many workers
  should the firm hire?
• If W gt MRP What action should the firm take?
• If W lt MRP What action should the firm take?
• The firm will maximize profits with respect to
  the hiring of workers when W MRP

5
A bit of history

• History of marginal productivity theory The work
  of J.B. Clark
• J.B. Clark (1847-1938) The first American
  economist to contribute to the history of
  economic thought.
• Ethical implications of Marginal Productivity
  Theory Labor, Capital, and Land are paid
  according to their economic contribution to the
  social product. Therefore analysis contending
  that labor is exploited are naive.
• Critique of Clarks position
• Violation of Humes Dictum That what ought to
  be cannot be derived from what is (i.e.
  normative statements cannot be derived from
  positive statements, or in other words, what a
  person should earn is not relative to what the
  person does earn).
• Conclusion depends upon perfectly competitive
  goods and/or factor markets. Is this true in
  professional sports?
• How do you measure a workers marginal product?
  This is true in professional sports.

6
The Monopsony Model

• Monopsony a single buyer in a market.
• Contrast with a monopoly.
• A monopsonistic firm faces the entire labor
  supply curve. To hire an additional worker the
  firm must pay higher wages to not only the last
  worker hired, but all workers the firm employs.
• Consequently the marginal expense of hiring one
  more worker will exceed the wage paid.
• A firm still maximizes profits with respect to
  hiring workers by equating the marginal expense
  of one more worker with the marginal revenue this
  worker creates.
• Implication Firms with monopsonistic power will
  pay wages that are less than the workers MRP.
  In other words, monopsonistic firms exploit their
  workers.
• Joan Robinson (1933) What is actually meant by
  exploitation is usually that the wage is less
  than the marginal revenue product.

7
The Reserve Clause and Final Offer Arbitration

• The Reserve Clause At some point in the history
  of each major sport athletes were restricted by
  a version of the reserve clause.
• The reserve clause gives each team monopsony
  power in its negotiations with labor.
• Hence we would expect labor to be exploited.
• Final Offer Arbitration if a player and a team
  cannot agree to a contract, each side submits its
  final offer to an independent arbitration panel
  that selects on final offer or the other. No
  compromise is allowed.
• What is the advantage of FOA? By choosing one
  offer or the other, the sides are forced to be
  more reasonable (relative to a split the
  difference approach).
• Problem with FOA? Only the supply side is
  considered. Arbitrators compare a players wage
  to the wages of players with a similar level of
  productivity. What if these wages were chosen
  incorrectly? Because FOA does not consider the
  demand side of the market, these mistakes are
  repeated.

8
Salary Caps and the Draft

• Payroll Caps (Salary Caps) a maximum payroll
  figure for each team.
• The NBA Payroll Cap is a soft cap due to the
  Larry Bird Exception.
• The NFL Payroll Cap is a hard cap. Because NFL
  salaries are not guaranteed, every player (except
  those with large signing bonuses) is playing for
  his job.
• The Reverse-Order Draft
• Initially amateur athletes could negotiate with
  every team. Hence there was a free market for
  unsigned players.
• The monopsony power of professional leagues was
  eventually extended to eliminate this loophole.
• The first draft was introduced by the NFL in the
  1930s.
• Baseball did not introduce its draft until 1964.
  Foreign born players are still not selected in
  baseballs draft.
• Does the monopsony power of professional sports
  leagues lead to the exploitation of players? The
  answer to this question requires that we measure
  the marginal revenue product of professional
  athletes.

9
The Remainder of Our Discussion

• An Introduction to Econometrics
• Scully, Gerald W. 1974. Pay and Performance in
  Major League Baseball. American Economic Review,
  64, No. 6917-930. On-Line JSTOR
• Blass, Asher A. 1992. Does the Baseball Labor
  Market Contradict the Human Capital Model of
  Investment? The Review of Economics and
  Statistics, 74, No. 2 261-268. On-Line JSTOR
• Krautman, Anthony 1999. Whats Wrong with
  Scully-Estimates of a Players Marginal Revenue
  Product. Economic Inquiry, 37, No. 2 April
  369-381.
• Refer to the text.
• Berri, David J. 1999. Who is Most Valuable?
  Measuring the Players Production of Wins in the
  National Basketball Association. Managerial and
  Decision Economics 20, No. 8 (Fall) 411-427.
• On-Line http//www.interscience.wiley.com/jpages
  /0143-6570/
• Berri, David J., Martin B. Schmidt, and Stacey L.
  Brook. Stars At The Gate The Impact of Star
  Power on NBA Gate Revenues Journal of Sports
  Economics. (forthcoming). Refer to power points.
• Additional Chapter Seven Topics
• Human Capital Theory and the Training of Athletes
• Tournament Theory