The Economics of Professional Sports

1. The Economics of Professional Sports Sharp, Register and Grimes Chapter 9

2. 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.”

3. Question 1 • What does it mean for an industry to be subsidized? • In what kind of market structure are industries subsidized? Perfect competition? Explain.

4. 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

5. 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.

6. 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

7. 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?

8. Sports Leagues: formal organizations of individual clubs • American League/National League/Major League Baseball • National Basketball Association • National Football Association • National Hockey League

9. 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

10. Teams and Players • Unique relationship • Productivity is visible and easily measured

11. Question 3 • What is productivity? • What is the ‘usual’ relationship between productivity and a worker’s wages? • Is this relationship the same for professional sport players?

12. 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

13. 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?

14. 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.

15. Imperfect Markets • Question: How has the behavior of the professional sports clubs that we’ve 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?

16. 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

17. 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?

18. 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 don’t come, then everyone loses…

19. 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.

20. 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?

21. 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 firm—a shared monopoly

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

23. 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.

24. 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 cartel’s degree of monopoly power) • Why would this be true? • What is “monopoly power”

25. 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

26. So how does the cartel work? • Basically firms coordinate their behavior in order to act like a monopoly…limit 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

27. 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 fan’s attention?

28. 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?

29. 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?

30. 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 member’s sales territory in an effort to capture more than the agreed upon share of the monopoly

31. 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

32. 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

33. 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

34. 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?

35. 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?

36. The Resource Market • The employment of players • Monopsony: a market with only one buyer or one employer

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

38. Do professional athletes earn their pay?

39. 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?

40. 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 cartel’s 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?

41. Even More Questions! • Discuss the economic pressures and incentives for professional sports teams to relocate. Are professional sports teams an important tool for a city’s 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?

42. 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.