Download Economics 2120 Economics of Professional Sports Sept 16, 2009

Economics 2120
Economics of Professional Sports
Sept 16, 2009
European sports leagues often have a promotion/relegation system - which is a
system in which multiple leagues work in vertical integration and with the
understanding that the top teams in each leagues every year move up and the
bottom teams in each league every year and they move down into the league
below. This is a much more open system than North American leagues.
there is a significant penalty for teams that are relegated as teams that are
relegated face a huge drop in revenue.
it is difficult to isolate what teams are actually producing and what each individual
member of the labour force on that team is individually producing
another interesting thing about professional sports leagues is that there must be
at least two firms in the league before anything can be produced.
size of pro sports leagues can be defined by:
Market value of total assets (common in finance) - arena’s, player contracts,
equipment, office buildings, etc.
Market value of total output - ticket sales
Revenue - dollar value income
The est. size of the entire pro sports industry : $441 billion
Individual league revenues are small: NFL $6.54 billion, MLB $6.08 billion, NBA
$3.57 billion, NHL $ 2.44 billion
other revenues (publishing, facility construction, food services, licensing, travel,
gambling etc.) $173 billion
sporting goods sales, apparel, equipment etc. $77.3 billion
the entire pro sports ind was roughly 3.08% of the US economy in 2008 - while
that may seem small thats twice the size of the US auto ind and seven times the
US movie ind.
attendance figures can give an impression of the financial health of the four
professional sports leagues in north america
Pro sports ind are unique b/c:
they are allowed to engage in business practices that are illegal in any other ind.
Leagues have been granted special privileges under a series of historical court
cases and gov leg in 1915 a failed baseball league sued the NL and AL
because they were doing illegal business practices (profit sharing, trusts) the NL
and AL were found Not guilty in 1922 setting a legal precedent that has lasted
ever since.
each club in a league is a member of a monopoly that represents the club
owners. Monopolies can only survive if they can prevent other competitors from
entering the ind.
New Franchises must be approved by a majority (typically2/3) of club owners.
Franchise fees can be large (typically $150 million in the NHL
The League as a monopoly contracts for broadcasting, merchandising and logos.
The monopoly can extract higher fees this way than if each club acted alone.
pro sports leagues increase their revenue and control costs by using
revenue sharing (MLB and NFL) - Each season each club contributes 1/3 of
their local revenue to a central fund which is then split evenly to all the clubs in
the league. in place since 1876 in the MLB. the idea is that it maintains the
financial viability of clubs that operate in small markets. As a by-product it
reduces player costs.
Salary Caps (NFL, NHL, NBA) - roughly the same in the three leagues total league pay role is capped at 55% of league revenues. that number is
divided by the number of teams in the league. Any overage above the cap is
taxed at a 100% rate and that money is redistributed by the league to the teams
under or at the cap.
Luxury Taxes (MLB) - a payroll threshold is established that every team is
to be at or below . if a club exceeds that threshold they pay 100% tax but b/c only
two teams pay the tax - the NYY and the BRS. again the overage is taxed and
then redistributed to the teams below the threshold.
technically these systems are illegal under the Sherman Act in the US since they
reduce competition, yet they are tolerated and in some cases encouraged.
the reserve clause - est in 1879 in the NL that was applied to all players on a
clubs roster. it was a standard clause on a players contract that stated that if at
the end of a season the owner and the player couldn’t agree on a salary for the
next season the player is then reserved to play the next season at the same
salary as the previous season. The player isn’t free to go to another club as they
are reserved. This was struck down in 1976
Monopoly Behaviors of Pro sports Leagues
Restrict entry of new clubs
Restricting relocations of existing clubs
Assigning exclusive franchise territories
Adopting revenue sharing systems
Acting as an exclusive dealer for broadcasting, merchandising and logo rights
These practices are not subject to antitrust laws due to the precedent setting
case of Federal League v. Major League Baseball (1922) and the Sports
Broadcasting act of 1961, although courts and governments are becoming less
accommodating.
Despite owners claim that these practices are necessary for the survival of the
leagues, economics can easily show that these policies act solely to increase
profits.
Sept 23, 2009
supply and demand lies at the heart of pricing decisions. When you see changes
in prices, think of supply and demand.
the demand curve - combinations of prices and quantities that consumers are
willing to purchase. or also the maximum price consumers are willing to pay for a
certain quantity of product.
we must define the product carefully in order to think of a demand curve for it.
Telus has a monopoly over home phones but by re-defining their product as a
communication product. the demand curves for communications products and
home phones are then very different.
revenue = price x quantity
the law of demand - assumes that the quantity of goods purchased increases as
the avg price falls. we assume that this holds for any good or service. we also
assume that
income doesn’t change
prices of similar goods are constant
taste are constant
demand curves can shift to the left or right due to changes in:
real incomes
prices of substitute or complimentary goods change
tastes of consumers
we can distinguish b/w normal goods and inferior goods.
Normal good - a good which when income increases the demand curve
shifts right. most goods are normal goods
Inferior good - a good which when income increases the demand curve
shifts left. generally low quality staple goods.
for the most part, pro sports tickets are normal goods.
complimentary goods - goods that are usually consumed together. if the quantity
of good A sold increases while the price of good B decreases we say that the
goods are complimentary.
if the quantity of good A sold decreases when the price of good B decreases then
these are substitute goods.
pro sports teams can also shift the ticket demand curve by changing the quality
of their teams, just as manufacturers can do by changing the quality of their
products.
price elasticity of demand measures the sensitivity of tickets purchased to
changes in the avg ticket price.
nD = (%changeQ)/((%changeP) = ((Q1-Q0)/((Q1+Q0)/2)))/((P1P0)/(P1+P0)/2))
price elasticity of demand is always negative but we ignore that and we assume
that the demand curve doesn’t shift.
when elasticity is >1 the demand is elastic and an decrease in price will lead to
an increase in revenue.
when elasticity is <1 the good is inelastic and an increase in price will lead to a
increase in revenue.
the income elasticity of demand gives an estimate of how ticket purchases will
respond to an increase in real income. it gives a measure of the magnitude of th
shift of the ticket demand curve
if the income elasticity is > 0 then the good is said to be a normal good
if the income elasticity is < 0 then the good is an inferior good
suppose real income increases per capita from 50000 to 55000 and ticket sales
increase from 15000/game to 16000/game. we can tell that tickets are a normal
good b/c they increased thus the income elasticity must be above 0
NHL hockey tickets are either weakly inferior or weakly normal meaning that
hockey ticket prices are not very sensitive to changes in peoples income.
Supply Curve - the combination of prices and quantities that can be produced. or
as the Minimum price a producer requires to produce a given quantity of output.
the supply curve usually slopes upwards since greater amounts of output raise
producers costs and increases the minimum price needed.
the cheaper it is to increase production, the less the increase in price that is
necessary and the supply curve is flatter
the supply curve can shift to the right due to
across the board reduction in factor costs
increase in factor productivity (technology, training, experience)
increased availability of factors (larger stadiums)
optimal weather conditions
to determine the equilibrium price, we place the demand and supply in the same
diagram and determine the intersection point.
forces move us back to the equilibrium point when we move away from it for the
last customer, the maximum price that he or she is willing to pay is just equal to
the minimum price the producer requires. Thus there is nor shortage or surplus of
product.
Consumer surplus - is the total difference b/w the max price consumers are
willing to pay for a product and the price they actually do pay. this represents the
total value to society of the product, but not the marginal value to each individual.
Graphically it is represented by the areas under the demand curve and above the
equilibrium cost
producer surplus is the total difference b/w the equilibrium price and the minimum
price the producer needs for each unit. this isn’t the same as profit but it is
related
the equilibrium price maximizes the sum of the consumer and producer surplus.
Sept 30, 2009
do questions 2 and 3 on page 41 and question 5 on page 61. Due on OCT 7.
read chapter 1-3
PSL - personal seat license - fee for the right to buy season’s tickets
Marginal product = Change in total product / Change in Labour input
roster sizes are fixed so what we are hiring is talent. so MP is really the change
in the output (Q) / Change in T (talent)
we assume that output is produced from a production function that transforms the
amount of inputs into an output. we right them as
Q - output
K - capital - goods used to produce other goods
L- labour or in our case T for talent
we assume that the production function has diminishing marginal returns.
the marginal product of talent is the slop of the production function. as long as
the Marginal product is a positive number then output is increasing
economics dictate that you pay a player his worth in the Marginal production
clubs set the amount of talent they want by the size of the market
there is a wage rate per unit of talent and that is = to $MP
the surplus of talent goes to the owner. it is the area under the Marginal product
line and above the team payroll on a graph
economic rent is the difference b/w the salary they get minus the salary they
would get in their next best occupation. there is usually a massive surplus in
economic rent and this is were there the struggle b/w players and owners arises.
starting salaries for rookies are very high b/c the probability of actually making it
to the professional leagues is very s,all. players must be compensated for the
expense of training and the risk of not making a pro league. when uncertainty is
present, individuals must consider the expected value of a decision as compared
to the certain value of the alternate action
a young hockey player could maybe earn 45,000 dollars per year with no risk or
pursue a hockey career, w/ a probability of only 0.01 of making the NHL.
Expected value = pS + (1-p)W
where p is the probability of making the pro league
s is the salary if the gamble succeeds
w is the wage if the gamble fails
Expected value = 0.01($4,500,000) + 0.99($0)
=45,000 - In this case since the two values are equal the risk
is neutral and the individual is indifferent. If the individual prefers the certain
outcome, he or she is risk averse. Risk loving people prefer the gamble
Chapter 3
Economic profit = revenue - operating costs - opportunity costs
opportunity cost is the revenue is the revenue foregone in the next best
alternative business.
Marginal Revenue (MR) = the increase in total revenue/ the change in output
Marginal revenue is the addition to total revenue from one more unit of output
that is sold (typically we make this one)
Marginal Costs (MC) - change in total costs / Change in output
MC is the addition to total costs from one more unit of output that is sold. MC
typically increases as more output is produced since we assume that costs rise
at an increasing rate
Profit maximizing - When MR=MC for the last unit of output produced and sold,
the firm is maximizing profit at this level of output.
for the last unit of production profit = 0 but for all previous units MR>MC and
profits will increase
Characteristics of Perfect competition
Many firms producing and identical product
easy entry and exit in the industry
no single firm has the ability to influence the market price since each firm is
a small proportion of total industry output *Most Important*
sometimes only a small number of firms are necessary to generate a great deal
of competition. if the Threat of entry of new firms is great, then the existing firms
will price very competitively.
if no firm has the ability to affect the market price then the price is established by
collective actions of the firms in the industry even thought the firms don’t
organize in andy collusive way. the market price is determined by the intersection
of industry demand and industry supply.
the demand curve for a perfectly competitive firm is completely elastic b/c its own
level of output is a very small proportion of total industry production. The demand
curve is a horizontal line.
AR is average revenue AR = total revenue / output = p when firms are in
perfect competition
for pro sports leagues most costs are fixed costs ( transportation, player salaries,
equipment, etc.) these costs don’t change with the amount of tickets sold.
MC is the increase in total costs (TC) and are assumed to increase at an
increasing rate.
TC = FC + VC,
ATC = TC/Q = (FC/Q) + (VC/Q)
firms in perfect competition can only control its costs by controlling output. it will
maximize profit when MR=MC and in a perfectly competitive market MR =P and
AR thus P=MC maximizes profit.
in a perfectly competitive market profits are driven to 0 by continual new entrance
and extra production. firms will enter the ind as long as they see product.
eventually price = ATC and there is no economic profit but there is still an
accounting profit.
Oct 7 2009
short run - a period of time in which a firm can change only its labour inputs but
no other inputs
long run - a period of time in which all inputs can be changed.
the long run outcome for firms in perfect competition is that the market price will
continue to fall as new firms enter the market until the price equals the lon-runavg-cost. the long run avg cost curve connects the minimum points of all the
short-run-avg-cost-curves for different levels of capital or some other factor of
production.
the LRAC curve gives the minimum AC output for each level of capital.
returns to scale
Increasing returns to scale - long-run AC declines as output increases.
Decreasing returns to scale - long-run AC increases as output increases.
Constant returns to scale - Long-Run Ac doesn’t change as output
increases.
monopoly characteristics
only one firm in the industry.
there are barriers to entrance to the industry, usually enforced by the gov
has market power and thus can set the price anywhere along the industry
demand curve
must be able to prevent the entry of new firms (legally or illegally)
the same principle applies in profit maximizing in monopolies where MC=MR for
the last unit of output sold
b/c the ind demand curve is downward sloping (law of demand) P=MR does not
hold. the monopolist must lower the avg ticket price for all tickets in order to sell
additional tickets. this is b/c we assume that monopolist cannot auction single
tickets at different prices.
the profit maximizing output for the monopolist is at the unit of output where
MR=MC at the highest price people will pay (on the demand curve)
economic model of a pro sports club
each club operates in a geographically protected market
all costs are fixed costs (player and management salaries, stadium rental,
equipment, travel, etc)
there exists a maximum stadium capacity and thus an upper bound on the
number of tickets that can be sold
in this special case with all fixed costs, marginal cost is zero up to the maximum
capacity number of tickets (as ticket sales increase, costs remain the same).
however to sell the one ticket over the stadium capacity and the stadium must be
expanded and this is massively expensive.
following the same rule as all businesses the owner goes to where MR=MC
which is zero.
when a club is profit maximizing MR=MC=0 and the price elasticity of -1 or unit
elastic
an increase in stadium capacity, without affecting the demand curve, does not
affect ticket prices or ticket sales
An increase in payroll costs, without affecting the demand curve, doesn’t affect
ticket prices or ticket sales.
Stadium capacity should be increased if a club is operating on the elastic portion
of the demand curve.
Oct 14, 2009
club owners face two types of taxes on their earnings
taxes imposed by various levels of government
taxes the league imposes on themselves to redistribute revenue among
clubs
economics suggest that taxation is based on two guiding principles:
Ability to pay - tax high income earners the most. AKA a progressive tax
system
Equality of taxation - equal taxation for all or a flat tax. e.g. AB provincial
income tax.
Canada’s tax system is a blend of these two principles and has resulted in a
progressive income tax system. Due to a large number of deductions from
taxable income for the wealthy, the U.S. tax system is closer to being regressive
Club owners pay a personal income tax rate if they own the club personally and
receive all profits of the club personally. Or they could pay a corporate income
tax rate if the club is owned by a company. setting up the club as a corporation
has tax advantages.
the Veeck tax shelter changed the business of professional sports. it is a tax
shelter that is only applicable to pro sports clubs, no other businesses. how the
tax shelter works
1. purchase a club and restructure it as a Subchapter S corporation. this is
a corporation that only exists in pro sports.
2. it is a corporation thus it pays the corporate income tax but the owner
still gets to keep all the profit.
3. the value of the player contracts are valued up to 90% of the purchase
price of the club.
4. Players contracts can thus be depreciated over a five year period (20%
per year) against revenue.
5. At the end of five years, restructure the club as a normal corporation to
move into a lower tax bracket or sell the club.
Oct 21, 2009
assets of a pro sports clubs are made up of
player contracts
management
equipment
stadium or arena if owned
brand and image
future revenues
ideally the market value of a sports club is the amount the owner can expect to
receive by selling the club and its assets today.
we can note some interesting characteristics of franchise values in pro sports in
North America
rate or return (% change in franchise value) has been impressive: 8% in
MLB, 16% in NBA and 20% in NFL up to 1990.
owners tend to sell clubs after losing seasons (around 53% of the time in
MLB and NBA, 59% in NHL and 68% in NFL)
The NHL has had the most stable ownership up to the ’60’s since the ’60’s
all leagues have experienced unstable ownership and rapid increases in the
number of franchises. All leagues, except baseball, have suffered from
competition from rival leagues.
the present value of a future stream of income is the amount of money to invest
today at some rate of interest to earn the stream of income.
so the present value model predicts that increases in franchise values is due to
increases in expected future profitability. But expectations are volatile and so are
franchise values
the model also predicts an inverse relationship b/w franchise values and the
interest/discount rate if the expected future profitability doesn’t change
if the club is not sold for an infinite period of time and expected future profits are
constant or growing by a growth rate g, then use:
present value = y/(i-g)
for an infinite period :
present value = y/i
economics suggests that the rate of return on a pro sports franchise (or any other
investment) will just equal the avg market rate of return in the long-run. this is b/c
of arbitrage
as investors bid for the club, they raise the current franchise value until the
equality holds
if the equation is less than the avg market rate of return then the current
franchise value gets bid down until the equation equals the avg market rate of
returns
we have odd results that the only way a franchise value can increase faster than
the market rate of return is if the club is making annual losses
the results suggest that
franchise values cannot appreciate faster than the market rate of return in
the long-run
in the early years of pro leagues, franchise values should increase quickly,
then more slowly as the league matures
in reality though we see that franchise values appreciate much faster once the
league is established and don’t appreciate quickly early on.
Ch 5 Parity in League Play
parity measures the closeness of each contest coming to the flip of a coin.
perfect parity means that the probability of a team winning a contests is 0.50
the objective of the league is to find the profit maximizing level of parity. they can
do this with
salary caps
revenue sharing
luxury tax
a good measure of parity is called the idealized standard deviation. this is a
measure of how dispersed winning percentages will be in a league that exhibits
perfect parity.
not every club will have a 0.500 winning percentage due to random occurrences
during the season
if the idealized standard deviation is 0.5 plus or minus a certain amount and as
long as all the winning percentages for all the teams fall within that amount the
league is said to have perfect parity
n is the number of games each team plays
p is the probability of winning which in perfect parity is 0.5
thus we can calculate by
square root of P(1-p)
n
so if a club plays 20 games its square root of (20x.5x.5) = 2.24 thus if all the
teams in the league win b/w 7.76 and 12,24 games the league is in perfect parity.
the ratio of the actual standard deviation of winning percentages to the idealized
standard deviation gives a measure of parity.
Oct 28, 2009
we can construct a simple model to show how clubs interact to determine
revenues, profit and parity league.
assumptions
the league consists of only two clubs. Team A operates in a large market,
while team B operates in a small market.
revenue is an increasing function of winning percentage at a diminishing
rate
free agency is allowed and clubs are allowed to trade players or sell them
for cash.
talent, in the short run, is in a fixed supply
we use these assumptions to asses the effects of revenue sharing, salary caps,
and luxury taxes on league parity.
because Team A is in a larger market than team B at any given winning
percentage team B is always making less revenue than team A.
Marginal Revenue in this case is the increase in revenue from increasing the
winning percentage one point. MR = to the slope of the revenue curve.
the profit maximizing winning percentage for the league occurs where the two
marginal revenues intersect. this is b/c the total revenue is the area under the
marginal revenue for each club.
the invariance principle states that the final distribution of talent in a league is
invariant to who owns the property rights to players talent (owners = reserve
clause and cash sales. players = free agency).
the profit maximizing condition is MR=MC and in this case MRa=MRb=MC
a reserve clause reduces the MC of talent. this causes a problem in our model as
both teams can buy more talent and increase their winning percentage and
increase their profit. what happens is teams will violate the reserve clause until
the MC has been driven back up and equilibrium is re-achieved.
thus we can conclude that reserve clauses don’t promote parity b/c of the profit
incentives of owners.
we can investigate the effects of revenue sharing on parity and salaries in our
two team model by assuming a simple revenue sharing system. the home club is
allowed to keep x% of its gate revenue while the visiting team receives (1-x)% of
the gate revenue.
team A increases its revenue when it increases its winning % by 1%. this is the
MR for Team A. However, when it does this, Team B lowers its winning % by 1%
and Team A must share in the loss of revenue sharing.
the MR for both clubs are lower than they are w/o revenue sharing at a given
winning %. In our two team model, both MR lines shift vertically.
revenue sharing we can see then has NO effect on parity in a league. it does
shift wealth from wealthy teams to poorer teams. the largest effect is that MC is
driven down aka player salaries are forced down.
Nov 4, 2009
ultimately a rival league wishes to merge with the existing league to increase
profit.
merging takes advantage of increasing returns to scale. average costs decline as
more tickets are sold.
two problems may prevent mergers
different collective bargaining agreements, revenue sharing arrangements,
TV rights and so on.
some clubs may vote against a merger since they can do better by cheating
on the cartel
strategic behavior mean anticipating the rival’s response to a possible strategy
and incorporating that expectation into profit-maximizing decisions.
we can define three types of expectations we call conjectural variations
Cournot conjecture - anticipate no response from the rival
Competitive conjecture - Anticipate the rival will do the opposite
Collusive conjecture - Anticipate the rival will do the same. Not necessarily
a rival in this case.
just the credible threat of entry of a new firm or league can affect the behaviour of
the existing league or firm
Nov 18, 2009
the last twenty years have seen a boom in new stadiums being built. A large part
of this is b/c the avg shelf life of a stadium is about 25-30 years.
Economists really only care about the construction of new stadiums if public
funds are used. If you are going to privately finance the construction of of a new
stadium privately, its your own problem.
Since 1990 64 new stadiums and arenas have been built in the four professional
leagues in North America.
construction costs since 2000 have averaged
NFL - 398 Million (excluding Cowboys stadium, 452 Million with it)
MLB - 399 million (excluding new Yankee stadium, 474 million with it)
NBA - 229 million
NHL - 236 million
construction costs in the 1990s
NFL - 224 million
77% increase
MLB - 223 million
77% increase
NBA - 162 million
41% increase
NHL - 165 million
41% increase
using the Consumer Price Index we can calculate the inflation rate (value of a
basket of goods at a given time / same basket of goods at an earlier time) the
CPI for Canada has increased by an average of 23% from the 90s to the 2000s.
this means that the majority of the increase in constructions costs is due to
quality improvements.
in the US local and State govs have provided significant portion of the funds
needed for new facility construction. In Canada there has been very little public
money or support for the construction of stadiums or arena’s
other sources of revenue to finance stadiums construction and ongoing costs
come from three sources:
Commercial licensing agreements
Personal seat licenses
Naming Rights
Commercial licensing agreements - cover things like parking, concessions
and souvenir sales.
typically these contracts are agreed to with an outside vendor and can take the
form of fixed payments per season, royalties that are a percentage of sales or a
blend of both. the Larger the fixed fee, the lower the royalty. Fixed fees can
also be collected before construction while royalties cannot be collected
until after construction is completed.
the disadvantage of a royalty system is that imposes a deadweight loss in
revenue. this is revenue that consumers are willing to provide, but don’t b/c
the output isn’t made available.
the Royalty is like a tax that the vendor must pay to the stadium owner. this shifts
the supply curve vertically up by the amount of the tax.
a PSL is a way to extract consumer surplus in conjunction with selling seasons
tickets. PSL’s are often used to finance construction costs of a new facility. the
New York Jets and Giants are building a new stadium worth 1.7 billion and 20%
of the cost has already been covered by the sale of PSL’s
economists suggest that a PSL is an option contract - the option to purchase
game tickets in a specific seat. if the option isn’t exercised the stadium has the
right to sell the ticket without giving any seat revenue to the PSL holder.
revenue gained from PSL’s isn’t subject to revenue sharing
A PSL lowers the price a consumer is willing to pay for a seat ticket. it simply
collects a portion of the ticket price in advance.
Nov 25, 2009
why do governments subsidize the construction costs of new facilities
social and psychological benefits are large but hard to measure.
These confer a positive externality on local consumers.
sports clubs and facilities can generate large economic benefits in some
cases. usually underdeveloped areas with high unemployment that need
revitalization. Often this kind of development simply replaces other economic
development so there is no real net improvement.
Public participation in financing new construction qualifies local
governments for federal tax credits, offsetting some costs at the expense of
federal taxpayers
Public officials can feel overwhelmed.
an externality is a benefit or cost imposed by one person or party on another
without their consent.
some cities compete with each other for a new franchise or to keep a hold on
existing ones by “bidding” for clubs with new facilities. This is subject to the
winners curse
the winners curse is the idea that in order to win the auction the winning
bid be so high that it will exceed the benefit from hosting the new club.
When you win you actually lose.
most privately owned clubs cannot afford new facility construction. An NFL
stadium costs on avg $500 million currently.
two broad criteria are required to justify the use of public money to build a new
facility
the project must confer positive direct consumption benefits that are
greater than the required financing
a positive net contribution to economic development in the
community.
direct consumption benefits - are measured by the net increase in
consumers surplus over and above the consumers surplus that already
existed before construction (and likely will disappear). It also includes the
consumers surplus from any new businesses that arise from construction
of the facility (motels, restaurants, apparel stores etc)
indirect consumption benefits - they are typically a lot smaller than direct
but they are easier to measure. they are benefits that include any increase
in income over and above the incomes that already existed before facility
construction. these increases in income could arise from
greater motel and restaurant income
apparel and merchandising income
Stadium and club employees.
note that incomes of construction workers are not included since these are a
transfer of income from local taxpayers, unless ther source of funding has come
from outside the local area. in this case greater income is being imported from
other areas
usually net increases in income are multiplied by a multiplier number (around 1.5
typically) since persons spending is another persons income. divide the initial
increase in income and divide it by the percentage of money saved. for example
a 500 dollar increase when people save 10% is 500/0.1 = 5000
one person is gets 500 and saves 10% and spends 450. the next guy gets
450 and saves 10% and spends 405 and the next guy gets 405 and he saves
10%...........
What are the relevant costs?
Annual facility operating costs (discounted to current dollars)
Annual team operating costs (excluding player salaries)
Environmental and congestion costs.
interest on any borrowing for financing
economics suggests that relevant costs are opportunity costs of construction,
since these represent the sacrifice of the next best alternative use of funds
(hospitals, schools, infrastructure). Again this is virtually unquantifiable
if a city has near full employment, then construction costs might be a good
estimate of opportunity costs since these workers would be building another
project anyway. If unemployment is high, then their opportunity cost is low and
construction costs might overestimate opportunity costs.
Overall, for a public investment project to be feasible, we must have that:
Direct consumption benefits + Indirect consumption benefits - relevant
costs must be >0
this isn’t enough since there might be another project with a greater positive net
benefit than the sports facility
in general, public investment project is beneficial in three situations:
there exist unemployed resources that are best used by subsidizing
investment with public fund. In this case, the opportunity costs of these
resources are low. Private financing may not be available or may not be
able to earn a sufficient profit.
if resources are fully employed, society may be consuming too much
and investing or saving too little. There isn’t enough savings to finance
large projects like a stadium. For some reason, private capital markets
don’t realize this.
the rate of return for the investment project exceeds the rate of return
on all other public and private investment projects.
- economic impact analysis typically overstate net economic benefits from new
facilities for three reasons
The usual assumption is that if a facility is not built, the sports club will
relocate to a different city. they may threaten to leave but they often don’t
the estimate of the net direct consumption benefits usually doesn’t subtract
the direct consumption benefits from alternative forms of entertainment that
already exist in the city.
the net indirect consumption benefits are usually grossly overstated for two
reasons. first the net increase in incomes in and around the new facility is
overestimated since they don’t subtract the loss of income in jobs that are
eliminated. second the multiplier used to compute the final increase in local in
overly optimistic.
Dec 2 2009
Free Agent Categories
MLB - all players can be unrestricted free agents (requiring no compensation) if
the current player contract has expired and a new contract cannot be agreed
upon. A minimum of 4 years of major league service is required for unrestricted
free agency unless a renewing contract isn’t offered
NBA - same as MLB but with three years of service
NFL - unrestricted free agency after 4 years. there is a signing period from feb 12
to july 15 if unsigned after this period the player’s rights revert back to old club
restricted free agency - happens when contract expires and the players
have only played for 3 years. signing period is feb 12 to april 12. if player accepts
an offer from a new club the old club can match the offer and retain his services.
if the offer isn’t matched the old club receives draft choice compensation
depending upon the level of it’s last salary offer.
Franchise PLayers each club may designate one player as its franchise
player. the player must receive a minimum salary of the avg salary of the top 5
paid players in his position or 120% of his previous years salary, whichever is
greater. failing this, the franchise player can declare free agency with the old club
retaining the right of first refusal. compensations is two first round draft choices
Transition player - like a franchise player but only have to be paid avg
salary of the top ten paid players in his position. old club has right of first refusal
for seven days and if still refused no compensation is given.
NHL - unrestricted free agents - any player who is not re-signed upon expiration
of his contract
group 2 free agents - any player who has received an offer from his old club
upon the expiration of his contract. if the player is lost the old club receives
compensation of draft picks. old club retains the right of first refusal. 25 years old
or less
group 3 free agents - 27 years of or more with at least 7 years service and
fail to reach contract agreement. old club doesn’t have right of first refusal
group 6 players who are 25 years old with at least three years experience
and at least 80 games played.
player salaries must fall within league imposed salary cap for each club in the
NFL, NBA, and NHL
NFL - has a hard cap of 128 million per team for 2009-10. teams that exceed
their cap are subject to fines, cancellation of player contracts or loss of draft
picks. League salary cap is calculated as 56% of anticipated league revenue. the
minimum team payroll is 90% of the team cap.
player contracts are not guaranteed in the NFL so players can be released from
their contracts before the season starts and the salary won’t count towards the
cap. this is why signing bonuses are popular
NBA - same as NFL with 56% of league revenue. team cap was 58.68 million for
2009-10. it is a soft cap so a team can exceed the salary cap and not pay fines.
there is no specific penalty for exceeding the cap, however teams that do exceed
cannot sign free agents for more that the league minimum salary.
the NBA uses a luxury tax which applies if a club exceeds its salary cap and the
league avg payroll is below the cap. the proceeds of the tax are redistributed to
the clubs who are below their caps.
the NBA also has stipulated a max salary for individual players. this max
increases with years of league service. for a player with five years of NBA
service the cap is set at 25% of the team cap, with annual increases occurring
beyond 5 years of service.
NHL - a hard cap similar to the NFL except it is 58% if league revenue. for 200809 was 56.7 million/team and 11.34 million/player. Minimum payroll is 16 million
below the cap.
penalties for exceeding the cap include fines, contract cancellations or loss of
draft picks.
all player contracts are guaranteed.
the reserve clause was challenged in 1971 by Curt Flood, an outfielder with the
St. Louis Cardinals. Flood was traded to Philadelphia despite being without a
contract at the end of the 1969 seasons.
with the aid of the new player’s association president Marvin Miller, Flood took
his case all the way to the supreme court but he lost it. No active players spoke
on flood’s behalf, only retired players appeared. Flood retired after he lost.
Flood’s legacy was the introduction of a binding arbitration committee in the 1973
collective bargaining agreement to settle players dispute. the owners happily
agreed, believing that the committee would never be used.
Marvin Miller convinced Andy Messersmith and Dave McNally to play the 1975
season without signing their contract at the end of the 1974 season. They then
applied to the league office for free agency at the end of the 1975 season,
arguing that the reserve clause didn’t apply to them.
the three person arbitration committee ruled in favour of the players. When the
owners took the case to the US supreme court, the court noted that the
arbitration was binding and therefore irreversible. The Court ruled that any player
finishing a one year contract at the end of 1975 was a free agent.
the players union set in a restriction that a player can only be a free agent after 4
years of service.
a players salary is determined by the marginal product of talent multiplied
by the number of talent units that a player posses.
Salary = (MP x P) x T(for a particular player)
generally MP is higher for large market clubs
Dec 9 2009
if capital and talent are complementary factors then the demand for talent
will be more elastic (flatter) in the long run
if talent is increased then more capital is hired b/c it becomes more efficient. this
increase in capital will lead to a shift up in talent as the capital it is using is now
more efficient.
The demand for talent in the long run is a flatter line that joins the points along
MRP line and is the demand for talent. This is b/c in the long run it is easier to
make changes
in the short run nothing really changes if more talent is hired b/c capital isn’t
adjusted so if you hire more talent it will be less efficient b/c there is still the same
amount of capital and in the end there may be no net gain.
Generally in the long run the demand for talent (or capital) will be more
responsive to changes in the wage rate per unit (more elastic) when
the demand curve for the output (tickets) is more elastic
the more substitute inputs are available for talent or capital
the greater the share of club costs that are payroll (need to economize
on costs)
the more elastic (flatter) is the supply curve of talent or capital - in the
short run talent is in very short supply and the supply curve is very very
steep but in the long run through drafting, trading, and bringing in players
from rival leagues there is an abundance of talent and the supply curve of
talent will be fairly flat.
in pro sports league there are many people trying to sell their talent but
there are very few or maybe only one bidder (teams or league). this is
called a monopsony (when there is only one buyer in a market with many
sellers). in this case, the club exerts a lot of market power in determining
the wage rate per unit of talent.
as clubs wish to purchase more talent, the wage rate per unit of talent will
increase due to scarcity of talent (may have to bid talent away from other clubs)
total costs rises by more than just the wage rate for the additional unit of talent
since the wage must rise for all previous units of talent. this is the marginal
resource cost of talent and is the total payroll cost when one more unit of talent is
hired.
the monopsonist club owner will hire talent up to the point where the revenue
generated by the last unit of talent (MRP) is just equal to the increase in payroll
cost (MRC) no profit on the last unit of talent.
MRP = MRC is the profit maximizing amount of talent to hire. The wage rate per
unit of talent is given by the supply curve and the space b/w the supply curve and
the MRP is the profit to the owner.
under the reserve clause Scully (1974) found that players were not payed there
MRP. this was confirmed again in 1968 and 1977. however in 1990 it was found
that players were actually overpaid and paid at a higher rater than the MRP.
in many sporting events, MRP is difficult to measure and prize money is offered
based on the order of rank at the end of the tournament. economists refer to
these competitions as rank-order tournaments. economists believe that
tournaments are set up this way to compensate pro athletes for the high costs of
being expertly skilled and provide incentives for good performance.
the distribution of player salaries has been shown to affect club performance, but
there is a trade-off b/w equality of salaries and individual incentives.
Hierarchical pay effect: greater pay for greater skill gives a positive influence
however, this can cause dissent in a team. and worsen club morale
compressed pay effect: smaller dispersion of salaries increases club morale but
at the expense i highly talented players.
it was found in 2000 that a greater dispersion of club salaries improved the
performance of star players but