Econ 1 Exam
Terms
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- Scarcity
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Everything that is paid for is a scarce good
Demand comes from scarcity - Demand
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Demand is the relationship between prices and the “quantity demandedâ€
-The most common sports example is the relationship between ticket price and attendance
EX:
Price = 32 – 4*Quantity
Willingness to Pay
Downward sloping demand creates Consumer Surplus - 5 Determinants of Demand
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Income
Price of substitutes
Tastes and Preferences
Future Expectations
Population - Importance of Market Power
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Perfect Competition
-No Economic Profits
-Market Output
Monopoly
-Economic Profits
-Restricted Output
Graphing Example of Perfect Competition vs. Monopoly - Elasticities for demand
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Elasticity of demand equals ε = -(P*ΔQ)/ (Q*ΔP)
If ε > 1, demand is elastic (not steep)
If ε = 1, demand is unit elastic
If ε < 1, demand is inelastic (steep) - Total Revenue
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Total Revenue (TR) = P(Q)*Q
Sources: tickets, television, sponsorships - Marginal Revenue
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Marginal Revenue (MR) is the change in revenue from one extra unit of quantity
MR(Qi) = TR(Qi) - TR(Qi-1) -
Equations if demand is a linear function
i.e. TR, MR, and P(Q) -
P(Q) = a – b*Q
TR = a*Q – b*Q2
MR = a – 2bQ - Know how to graph total revenue with respect to Q
- MR(Q*) = a – 2bQ* = 0
- Alternative revenue sources
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Often sporting events generate other types of revenue for the owner
-Parking
-Concessions - Shifts in Demand
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Since revenue increases with a demand increase, owners try to increase demand in different ways
New stadiums
Bill Veeck (Bat day, Disco demolition night) - Price Discrimination
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1.Revenue increases if owners are able to segment the market
2. Different prices for the same good
-Elderly fans, Children, Discounts
Differentiating products
-Different seats, opponents
-Different time of week or day (opportunity cost) - Revenue Sources
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gate sales, stadium arrangement, concessions, parking, licensed products, & selling rights to broadcast games
Media is the 2nd highest source of revenue in sports and is growing with new types of media
More cable outlets and internet
Media outlets are losing market power - Media revenue
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Big media contracts increases league and team revenue
The media wants rights to games so they can sell advertising - Know Sports, Advertisers, and media chart
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- Selling Broadcasting Rights
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There are 2 ways teams sell broadcasting rights
-They can sell home games through their league
-National broadcasting contract
-Individual teams sell the broadcast rights
-Local market contracts
Broadcasting rights are sold by auction
Winner’s curse: winner typically overpays
Typically, the sports division of a media provider losses money
Price of rights > ad revenues
Buying sports broadcasting rights typically increases revenue for other shows
Ex: 1994 Fox, $350 million loss on football, but revenue increased 19%
However, sometimes broadcast rights still go too high
XFL? - Vertical Integration
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To avoid problems, sometimes firms vertically integrate
Media providers own teams
Ted Turner owns braves, Murdoch, Disney
CBS bought the Yankees, 78% loss (not always good!)
-Advantages to vertical integration of media providers and teams
-No high broadcasting rights
-Tax advantages
-More market power
-Consumption - Advertising Revenue
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Advertising rates are increasing
-More than $2million for 30 seconds during the Super Bowl
In the NBA, NFL, and MLB advertising can cover most of the player costs
-For some teams, it cover all player costs - Increasing Demand
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Advertising increases the demand curve
Advertising should always increase revenue - Advertising Choice
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-If ad revenue is greater than ad costs, then the firm should advertise
-Marginal Revenue Product = contribution of revenue made by an additional unit of input
-It is difficult to calculate the value of advertisements
The Super Bowl and Monday Night Football have the biggest ratings
Ex: if it costs $2million for 30 seconds of air time, Pepsi would need to sell an additional half-million 6-packs, at $4 a piece
-Hard to say if new sales come from new consumers or established consumers - Marginal revenue Product
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MRP= MR * MP
additional quantity sold * the price of those items - Game Theory
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Advertising vs. Not Advertising
When both firms advertise it is a strict dominance equilibrium, but not pareto optimal
Over time firms may implicitly collude or get an ad constraint - Sponsorship
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Another form of advertising is sponsorship
This includes stadiums
-Comerica Park, Ford Field
Events
-Buick Open, Tostitos Fiesta Bowl
Athletes
-Nascar - Advertising Effects
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Advertising does effect the game
-TV time outs
-Fan perceptions
-Increases player salary - Long Run Costs
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The highest cost to teams are player salaries
-This varies from about $15-80 million for a team in a major professional sport
Most other long run costs generally total about $25 million
In the Long Run all costs are variable
Everything can be changed in the long run
-Player Rosters
-Stadium Configuration
-Front Office Personnel
-On-Field Manager
-Player Development
-Insurance Coverage
-Borrowing Choices
-Team & Stadium Operations
-Quality of Team - Short Run Costs
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-In the short run, long run costs are fixed costs
-In the short run, short run costs are variable and can be changed
-Total short run costs are total fixed costs plus total variable costs
SRTC = TFC + TVC
-Attendance Costs
-Concessions
-Parking
-Logo Properties
-Stadium Experience - Balance Sheets
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-Balance sheet show teams revenue and costs or assets and liabilities
-However, many times a team’s balance sheet does not show all revenues and costs
-Owners can get a salary, take interest free loans, hire their other services
-These items make the balance sheet look like the team is making a loss
-A loss on the balance sheets gives owners power with player unions, stadium subsidies, and fans - Output
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-In many businesses, firm produce some object, which is their output
-In sports, winning is their output
-If teams win more games, their revenue goes up
When costs increase output should increase
-Teams with higher costs should win more games
-Efficiency or luck could be reasons otherwise
-Teams with better players win more games
Do not think of costs as per at bat or per minute or per point, but rather how much they help the team win
-Teams have diminishing marginal returns from their inputs
-It is harder to win when a teams winning percentage is already high - Profits
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A team’s profits are defined as their total revenue minus their total costs
To maximize profits MR = MC
This means the slopes of Total Revenue and Total Cost are equal
Ex: MR = 100 – 10Q
MC = 10 + 8 Q - Maximizing Profits table
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- College Profits & Benifets
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-In college, profits are increasing but low, in many cases negative
-Profits are lower at smaller schools
-College sports have other benefits
-College sports teams have other benefits besides revenue
--Helps advertising
--Alumni donations
--Better student applications
--Better faculty
--Better administrators
--Political support - Revenue Sharing
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-In professional and college sports, teams share the revenue they get with other members of their league or conference.
-Some teams may be concerned with maximizing league or conference profit
-This can drastically change the revenue functions of teams and give some teams less incentive to win - Sports Monopolies
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-Sports teams, and especially leagues, obviously control a significant percentage of the industry
-Most major sports leagues virtually have a monopoly
-MLB has anti-trust exemption - No Free Entry
-Teams generally have a local or territorial monopoly
-This creates a downward sloping demand curve - Monopoly Profits
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-To find the profit using the previous graph, we need to know the average total cost
AC = TC/Q
-Profit is equal to the rectangle in the previous graph
Π = Q*(P*-AC(Q*)) - Monopoly Outcomes
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-Prices are always higher in a monopoly, However, some cities find ways of keeping ticket prices low
Ex: Dodgers
-Quantity is lower in a monopoly
--3 MLB teams in NY?
--No NFL team in LA
Having a monopoly allows owners to make decisions called “single entity cooperationâ€
-Schedule
--Different schedules can bring different revenues
-Rules
--Can create more offense/defense, or what fans want to see
-Playoffs
--Create additional games with playoffs - Monopoly as a League
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Each major sports league is a monopoly
A league is able to stay a monopoly because of barriers to entry
-Leagues already have the elite players
-Alternative leagues have had mixed success
--USFL, XFL, ABA, PCL - League Expansion
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If a league wants to expand they can sell the expansion fees
The expansion fees should take into account revenues, costs, and interest rates. However, selling expansion fees do incur costs
-Original teams must play expansion teams that bring less revenue
-In the long run, the chances of winning a championship is less
Less talent, possibly less fan interest
--Contraction?
--Competitive balance
If expansion fees are higher than expansion costs, the league should expand
There is also national media contracts to consider, but this is a small consideration - Relocation
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Teams may want to relocate to maximize their revenue
-However, leagues may have a strategic incentive to limit relocations
LA in the NFL
-Leagues may also have an incentive to force teams to relocate
--Demolition of the PCL
--Negro Leagues - The model of a league
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-Assume that there are only two teams in the league
-Each team’s revenue depends upon their winning percentage
-However, it will depend upon other factors, which causes large market and small market teams
-We think of output as winning percentage
-Winning percentage is calculated as,
LOOK AT EQUATION
Where n is the number of games, and w is 1 if the team wins and 0 if the team loses - Graphing marginal revenue
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We can graph the marginal revenue of teams given their winning percentage
LOOK AT GRAPH - The model of a league 2
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Better players will have a higher MRP in a bigger market, because more people will pay more to see the good players
Good players might actually have a higher MP in smaller markets - equilibrium
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We can graph the marginal revenue of teams given their winning percentage
LOOK AT GRAPH
EX:
MRL = 60-60*win%(large)
MRS = 40-40*win%(small)
We can find equilibrium win percent, and price for total labor, and price of labor for each team - Empirical evidence
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There are multiple ways of computing competitive balance
-Gini coeficients
--Championships or wins
-Standard deviation of win percents
It may depend upon the sport whether competitive balance is increasing or decreasing - Luxury Tax
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-Luxury taxes do make a difference in winning percentage (when it is enforced)
- money you must pay for going over the salary cap.
LOOK AT GRAPH - Salary Cap
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-Salary Caps will also make a difference in winning percentage (Ex: NFL)
-Limits the amount a team can spend one player salaries
Graph - Individual Labor Supply
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-When wages increase, people will typically work more, up to a point
-Typically, people are on the lower part of that supply curve
-However, athletes are sometimes on the upper part
--If athletes become very wealthy, they may not want to work as much - Labor Demand
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-The demand for sports labor is what the owner is willing to pay for players
-As shown in the sport league model, marginal revenue decreases as win% increases
-Therefore, labor demand decreases with output (wins)
-Owners are willing to pay the MRP of the players
-MRP=MP*MR
-The players salary in a competitive market should be equal to the number of games the player helps the team win multiplied by the revenue that an extra win brings
-A labor supply and demand graph typically looks like any other supply and demand graph - Economic Rents
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-Typically, athletes incur large economic rents
-Economic rent is similar to producer surplus
Ex: Barry Bonds
--How much money is Barry Bonds making because of baseball?
-Before sports provided as much revenue, some elite athletes would take other jobs
Because of economic rents, the player’s labor is not measured in hours
All athletes will typically play the whole season
However, if players are paid more, maybe they will work harder? - Wage equilibrium
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-Athletes earn high wages because of their supply
-Although demand is needed, elite athletes earn high wages because not many people can do what they do - Player value
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-Players are worth their MRP
-MRP = MRxMP = what the player makes for the team
-MR is extra value fans place on winning
-MP is the contribution to winning
-This is also the same for managers - Player’s MRP
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-Scully (1974) was the first to bring this idea to sports
-He first estimates MP, then MR
-He then estimates the exploitation of the players - Player salary
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-Today, generally athletes get paid their MRP
--Not so in college
---Should college athletes be paid
-Owners attempt to keep the MRP of players
--Pro draft
--Reserve clause
---Economic rents - Decision rule for owners
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-If MRP > cost of adding player, then the owner should sign the player
-In a competitive market, (not a monopoly) salaries = MRP, which can be huge
Ex: Mark McGwire in 98, attendance went up 1.5 million, 20$ per ticket makes MRP = 30 million
Ex: one win in baseball is worth about $300,000 This depends on the market and how many game are actually won - Changes in MRP
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-If players get their MRP, they get paid more if MP or MR goes up
-This means the player must either improve or fans are willing to pay more
-Increase in demand, ticket price
Simple supply and demand analysis shows why salaries are high - Signing bonuses
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-If a player generates $10 million revenue per year for gate and TV sales, the player may earn some of it with a signing bonus
-Suppose that for signing a 8 year contract, the player should get $80 million, discounted at r = 6% this becomes $62 million
-If the player gets $12 million in a signing bonus, they will then earn $6.2 million per year
--Remember, this is based on expectations - Non-competitive markets
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-A league can collude since most athletes have a relatively low opportunity cost and high economic rents
-However, talent still goes to the same team
-Invariance principle – the distribution of talent is invariant to who gets the revenues, talent moves to its highest valued use - Winner’s curse
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-Remember, these salaries will be based on expected MRP
-Therefore, if a free agent goes to the highest bidder, that bidder may overvalue the talent
-This is known as the winner’s curse - Winner take all
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-Many sports, especially golf, has big prizes for the winner.
-This gives a large incentive for people to win and might attract many athletes
-This may explain large CEO salaries