Sports Economics
May 24, 2012
Exam 1 - Answers
The following scenario applies to questions 1 through 5.
Cowboys TE Jason Witten on prospects of winning a Super Bowl: 'You try not to think about the window. But obviously, we're realists'[1]
Jason Witten is only 30. But this year he'll be entering his 10th season in the NFL, which is hard to believe for the Cowboys veteran tight end."I think you enjoy the journey but most importantly this opportunity to take advantage of it," Witten said Saturday. But since he joined the organization in 2003, Dallas has won only one playoff game and struggled to build a team capable of becoming a perennial contender. As a result, some wonder if Witten, quarterback Tony Romo and linebacker DeMarcus Ware -- the Cowboys' most high-profile players -- will ever experience the same championship glory that many of their predecessors once did. Witten has spent the last four months seething about the 31-14 loss to New York Giants in the 2011 regular-season finale that killed the Cowboys' playoff hopes and kick-started their NFC East rival's march to the Super Bowl. "It crushes you," he said.
1.How might you measure the uncertainty of outcome between the Cowboys and theirfirst scheduled opponent in 2012, the NY Giants? (Hint: uncertainty probably rises with expected closeness of the outcome.)
Answer:The absolute strength of the team matters, so their winning percents would capture part of the uncertainty. Relative performance also matters, so one might calculate closeness by their relative winning percents.
2.The Cowboy’s lowest-priced individual tickets were priced at $12 while their lowest-priced season tickets cost $250. Given that there are only eight home games, why didn’t fans just buy individual tickets rather than season tickets? Is this price discrimination or not? Explain.
Answer: The sum of the eight individual tickets is $96, compared to $250 for a season ticket to the same games, but a season ticket guarantees seat location while individual tickets do not. This is not price discrimination if buyers purchase also the location and seat guarantee with the season ticket (i.e., if that matters to the buyer) and purchase neither with the individual ticket. In other words, if they are not buying the same good then we cannot state that charging different prices is price discrimination.
3.Given the graph above, which team would you supposehas more star players? Justify your response.
Answer: If we let L denote the small-market team (for lower quality) and H denote the large market team (for higher quality), this looks similar to figure 4-5 in the text. Since the short-run total cost curve is higher for the large-market team, and revenue is higher, we would assume the large market team has more star players on its roster.
4.Does the scenario represented in the graph above support the profit maximization hypothesis? Explain your response. It may be useful to briefly summarize the hypothesis in your answer.
Answer: The profit maximization hypothesis is that owners make all decisions to maximize profits. For both teams TR – TC is maximized at a point where winning percent is between zero and one. In this case the large-market team earns lower profit than the small-market team, but this doesn’t mean the owners are not following profit-maximizing strategies.
5.In the graph below, it is clear that the marginal revenue from hiring talent is equal across large and small-revenue markets in equilibrium. Using the graph, show how revenue imbalance leads to payroll imbalance and competitive imbalance. Be sure the graph is fully labeled and explain as needed.
$ $
MR large
MR small
Payroll of small
Payroll of large market market team
team P P
WL = 0 WL > WS WL = 1
Answer: The equal marginal revenue outcome is where MRL* = MRS*. Revenue imbalance is shown by the fact that there is a large-revenue market and a small-revenue market team in the first place. Every level of quality chosen is more valuable at the margin to the larger-revenue market team. The result in equilibrium is competitive imbalance since WL* > WS*. Payroll for the large-market team is larger than for the small-market team.
The following scenario applies to questions 6 through 11.
A recent editorial listed five major unresolved problems for MLB. One is as follows: “Ensure that revenue isn’t profit-taking. Owners on the receiving end of revenue sharing out to be putting the money back into their teams, not into their pockets. Spend it on payroll, on scouting, or on marketing, but spend it on making the organization more competitive. That benefits boththe individual team and the business of baseball overall. “
6.Illustrate with a graph or explain in words what happens if smaller-market owners are forced to spend their net receipts on additional talent.
Answer: Suppose the starting equilibrium includes the desired level of competitive balance. If smaller-market owners are forced to spend their net receipts on even more talent, then the league is over-reaching to attain balance. The small-market team cannot afford to hire additional talent given they are already profit-maximizing owners (there is no reason to assume they are not). If the desired level of balance were not already met, owners with different revenue size markets would reallocate talent (according to the invariance principle) until marginal revenue of the last unit of talent is equal, at which point balance would be ideal (although the winning percentages would not be equal across teams).
7.The table below illustrates the standings to date for Dallas’s MLB team within its division, and for the final standings of Dallas’s NFL team within its division. Which team is in a division with greater competitive balance? Justify your response using standard deviation. (Formula is below.)
MLB AL West / Winning Percent / NFL NFC East / Winning PercentTexas / .600 / NY Giants / .563
Oakland / .489 / Philadelphia / .500
Seattle / .457 / Dallas / .500
LA Angels / .444 / Washington / .313
Answer:
AL West standard deviation = .0614.
NFC East standard deviation = .0937.
MLB teams play 82 games, so the MLB ideal = .5 / n ½ = .5/9.05 = .055
NFL teams play 16 games, so the NFL ideal = .5 / n ½ = .5 / 4 = .125
Actual / ideal MLB = .0614 / .055 = 1.116
Actual / ideal NFL = .0937 / .125 = .7496
The MLB is closer to 1 than the NFL, so the MLB has greater competitive balance.
8.For the 1999 MLB season, Kevin Brown signed for $105 million with the Dodgers. Two years later, Alex Rodriguez moved to the Rangers for the MLB 2001 season for $252 million. Do you think that player salaries can rise forever? Justify your response.
Answer: Whether or not salaries can continue to rise depends on fans’ willingness to pay, the primary determinant of the MR portion of MRP. Since the real growth rate of the economy is positive, some portion of that increase may continually be put into sports. If other determinants of demand change or consumers choose not to put any increased income into professional sports teams, then salaries will not rise. Note: this question asks about player salaries, not a particular player’s salary. (Also note, since we have never mentioned inflation in class, it would not be an issue of primary importance for this question; however, if it was included there is no reason to assume the question of real income or real salaries would alter the answer.)
9.The MLB Texas Rangers’ success over the past two seasons (playing in the World Series) has led to an increase in ticket prices. Explain what linksexist between the increase in players’ salaries, the increase in the team’s success, and the increase in ticket prices.
Answer: Marginal revenue increases because demand increases, and when demand increases the price a team can charge for tickets rises. Because MR is a component of MRP and MRP is a player’s salary, salary increases with MR.
10.The Rangers recently signed 25 year old pitching star from Japan, Yu Darvish. The Rangers also have star player Josh Hamilton, currently batting .379 with 18 home runs and on pace for a record-setting year. Can you make any statement about how Darvish’s salary might differ by joining a team with a star like Hamilton versus joining a team without such a star? (Hint: consider the components of how a player’s salary is determined when justifying your response.)
Answer: Darvish’s salary is based on MR and MP. Because both players are on the same team, it may be difficult to determine whether changes in marginal revenue are due to Darvish or Hamilton. We do know that Darvish’s MP will be lower playing for a team with more stars than he if he were playing for a team with fewer stars, all else equal. This is because of the smaller relative impact on the team’s success due to the presence of diminishing marginal product. Because MRP = MR x MP, and the effects are likely to be smaller for Darvish playing for the Rangers, it is reasonable to suggest Darvish may be paid less to play for the Rangers than in smaller markets.
11.Using the invariance principle, evaluate owner arguments in favor of the draft.
Answer: The owner argument is that the draft more evenly disperses entering talent across teams. This means that owners that otherwise would not be able to obtain strong incoming players now have a chance to do so, but the invariance principle argues that the players will end up in their highest-valued use across the league whether there is a draft or not. Strong incoming players who end up on teams with revenues that cannot support that level of talent simply move to the same type of team that would have obtained them without the draft. Smaller-market teams do get to enjoy top draft pick for a short time before the players move on. If the smaller-market teams are wise they can trade for some of the value of that talent.
The following scenario applies to questions 12 through 14.
“Negotiations on a new CBA began in early 2011. The league claimed that it was losing $300 million a year (22 out of 30 teams were losing money last season) and proposed to reduce 40% of players' salary (about $800 million) and institute a hard salary cap (at $45 million per team) as opposed to a soft cap (at $58 million) currently in use. The union disputed those figures and opposed those changes. In May 2011, the NBPA filed a complaint with the National Labor Relations Board (NLRB), accusing the league of negotiating in bad faith by failing to provide critical financial data to the union and repeatedly threatening to lock out players. The NBA quickly rejected the complaint, saying that the league complies fully with federal labor laws. The union also considered the option of decertification, which allows players to file an antitrust lawsuit against the NBA. Negotiations continued in May and June. On the salary cap, the owners called for a system called the "flex cap" that limits payroll but penalizes teams if the team’s payroll exceeds the league's average payroll of that season.The union argued that it is still a hard cap because the ceiling would kick in eventually.On salary reduction, players offered to cut $500 million over the next five years (their share would be reduced from 57 to 54.3 percent). The owners instead proposed to cut $2 billion over the next 10 years. As a last-ditch effort to avert a lockout, owners and players met again on June 30, 2011, to negotiate, but both sides failed to reach a resolution on key issues The owners demanded a larger share, claiming that they were losing money. The players refused to cave in to owners' demands. Negotiations broke off, and the CBA expired.
12.What was the primary problemreflected by the fact that there was a work stoppage? More simply, why is there no room for a work stoppage in the simplest bargaining game?
Answer: The primary problem is asymmetric information. With the full, certain information setting in the simplest bargaining game, no work stoppages will occur. Each side of the bargain can calculate the true best position of the other side and knows exactly the other side’s best response. In this case, each calculates both sides of the bargain and chooses their best position. In order to make the most of the situation, no stoppage should occur.
13.Collective bargaining agreements are agreed upon by owners through leagues, and by players through unions. During the NBA lockout, there were reports of player dissatisfaction and of a push to decertify the union coming out shortly after one of the owners' proposals was presented. One issue of contention was a clause that would give teams the right to send players down to the developmental league and pay them at a drastically reduced scale. Compare the benefits to settling such a dispute via mediation versus arbitration. Which is most likely to be successfully utilized in this case?
Answer:Mediation allows negotiation, which may allow a mutually beneficial result to occur. The negative result is that both sides have an incentive to put forth drastic positions. Arbitration precludes any compromise, but forces both parties to negotiate more sincerely. In this case, salary is indirectly affected by the move to lower leagues. It is not clear how players would counter the owners assertion that they should not have to keep on the roster low-performing players. Arbitration might be more successfully utilized.
14.Lamar Odom signed with the Dallas Mavericks for the 2012 season for $8.9 million (the 4th highest salary). Odom previously had won the NBA’s 6th man award, given to the top non-starter in the league. His performance in Dallas was so lackluster, he was removed from the team on April 7th and was not given a share of the playoff money awarded to the team. How would you be able to tell whether Odom’s performance problems were shirking, or just a bad year?
Answer: One might check effort during workouts; one might compare his performance to other similar players. Because Odom was signed to a two-year contract rather than a long-term contract, Odom’s incentive to “shirk” should be low. Still, with an $8.9 million first year contract and $8.2 million second year contract, it is possible the high pay-off allowed some decrease in effort. Each of these suggestions calls to mind the importance of monitoring and incentives as methods of decreasing moral hazard (or hidden effort).
Update: “ The Mavericks will attempt to trade Lamar Odom by June 29…. Good luck with that. Despite only $2.4 million of Odom's $8.2 million 2012-13 salary being guaranteed, Mark Cuban isn't going to get much (if anything) for a player who was banned from playing by his own team. If the Mavericks can't deal him, the team will likely waive him. From
[1]SportsDay DFW, By Rainer Sabin / Reporter, 1:21 PM on Sat., May. 12, 2012. Available at