Sports Economics: Resource Market

1. Sports Economics:Resource Market By: Matt Goldstein

2. Employment of Players • Each of the major professional leagues (MLB, NFL, NBA, and NHL) have strict methods by which teams hire and fire players • All of the leagues have basically two ways to hire a professional athlete. • The Draft • Free Agency

3. Overview of a Draft • What is the Draft? • An annual event in which teams from a sport gather to take turns selecting athletes just entering the league. • Why Draft? • To promote a competitive playing balance among teams, sometimes referred to as parity. • To prevent any single club from hoarding all the top prospects entering the league each year.

4. The Draft • Under league rules once a player is drafted by a team, that team has EXCLUSIVE RIGHTS to that player. • No club can hire this player unless the team that drafted him first sells or trades away his rights. • Thus, new players become the “property” of their employing club. • Due to exclusive rights athletes had to either accept any contract offered by the club that drafted him or sit out. • Players had little, if any, real bargaining power and provided owners the opportunity to pay their players low wages.

5. Monopsony • Monopsony-A market with only one buyer or employer. • When league rules allow clubs to own the property rights to new player contracts, an imperfect factor market is formed or a monopsony • Ex: When only one club has the right to contract with a specific player, that club becomes a pure monopsony from a player perspective

6. The immobility of new players who have been drafted New draftees who wish to play are required to sign contracts that bind them to a team for a specific time period Players never have chance to sell services to highest bidder. New players become locked in to the team that drafted him. Because they are locked in the employing club becomes the only potential buyer of the players talents The highly specialized athletic talents and skills possessed by the players Most athletes specialize in one sport and train just for that sport. Skills are very specific and not transferable to other employment Athletes face limited opportunities for employment. Therefore they must accept sub par contract offers by there standards. Two major factors that create Monopsony power for pro sport teams

7. Few Definitions • Marginal cost of labor (MCL)-The change that occurs in a firms total labor costs due to hiring and additional worker, per unit of time. • Monopsonistic Profit- The difference between the workers contributions to a monopsonistic firms’ receipts and their wages. • Marginal Revenue Product(MRP)- The change in revenue experienced by a firm when it employs an additional worker.

8. Wages and Employment in a Monopsony • A monopsony has a + slope supply cure • So in order to attract additional workers it must increase its wage offer. This is seen in column two of the table • Because wages rise with each additional worker, so does the total cost of labor. Indicated in columns 2 and 3. • The change in total labor cost due to hiring one more worker is known as the MCL. Column 4 • The MRP falls as more pitchers are hired. Meaning each additional pitcher brings in less and less revenue. Column 5 • How many pitchers will they hire? They will continue to hire until MCL=MRP. So four pitchers. NOTE: All wages and costs are 1000’s. So when wage reads 300 its really 300,000

9. Graph of Wages and Employment of a Monopsony (from previous table) • Line SS represents columns 1(# of players) and 2 (wage) • The MCL curve is plotted using numbers form columns 1(# of players) and 4(MCL) • The MRP (column 5) plots pitchers hired vs. revenue brought in. • Point A represents where MCL=MRP. The optimum quantity. • Point B represent how much the 4 workers are paid. • So when four pitchers are hired the MRP is 900 and the wage per pitcher is 600. The difference b/w A and B is known as MONOPSONISTIC PROFIT. • The difference is 300,000 x 4(pitchers hired)=1,200,000 total profit • Recall that in a competitive labor market, additional workers are hired until MRP=Wage. This is point C • If it was competitive mkt, we would hire five pitchers

10. The cause of monopsony power in MLB • As we said earlier since players had no choice of who to play for they were asked to sign a basic playing contract by their franchise once drafted. • It became known as the RESERVE CLAUSE • The Reserve Clause gave clubs the exclusive rights.

11. Players answer to the Reserve Clause • In 1975, players organized and fought the owners in antitrust court. • They realized the reserve clause gave owners monopsony power and kept salaries below what they could get if it were a competitive market. • The arbitrator overturned the reserve clause in MLB and the players/ owners eventually reached a compromise. • The compromise said the employing clubs could hold exclusive rights to a players contract for a specified amount of time after which the player could file for FREE AGENCY.

12. FREE AGENCY • A free agent is a player whose contract is no longer held exclusively by one team. • This means that once they become a free agent they can sell there services to the highest bidder. • The impact of Free agency on a players salary for MLB can be seen in the figure 9.3 • The other sports soon followed MLB and instituted Free Agency. • Free Agency clearly reduced the amount of monopsonistic exploitation in sports Free Agency was just starting in 1976. Most players were still ran by a monopsony power.

13. So Do Professional Athletes Earn Their Pay? • Most athletes earn millions of dollars while the average households income is $42,000. • People often argue that athletes are overpaid. • However, economically, as long as an employer experiences an increase in revenue that is greater than the increase in costs due to hiring an additional worker, the employer can increase profits with a new hire. • So a club can make a profit and pay its players millions of dollars if those players generate even more millions of dollars in revenues. • Example: In 1988 the Los Angeles Kings(NHL) paid $15 million to the Edmonton Oilers for the right to hire Wayne Gretzky. The Kings then signed Gretzky to an 8yr/$20 million contract. They paid a total of $35 million to get him but it was estimated that Gretzky increased revenue over the eight years by as much as $52.1 million. So they profited more than $17 million. So in this case it would be looked at as Gretzky earned his pay.

14. Labor Disputes • Players in all four major sports formed labor unions to help fight monopolistic team owners. • LABOR UNION- A formal organization of workers that bargains on behalf of its members over the terms and condition of employment. • Pretty much player unions negotiate with team owners to determine the standards that are applied to all player contracts. • When owners and player unions cant come to an agreement it leads to labor disputes: either a strike or a lockout.

15. Strike A strike is a work stoppage initiated by labor (the players). Ex. In 1994, the players union in MLB called a strike that forced the cancellation of hundreds of games. Lockout A lockout is a work stoppage initiated by management. Ex. In 1994, NHL owners canceled half the season forbidding the players from returning. Strikes and Lockouts In both cases the major points of disagreement concerned the mechanics of how players would be paid and the conditions necessary for players to become free agents.