Chapter 8 An Introduction to Labor Markets in Professional Sports FIFTH EDITION The Economics of...

Chapter 8

An Introduction to Labor Markets in

Professional Sports

FIFTH EDITION

The Economics of Sports

MICHAEL A. LEEDS | PETER VON ALLMEN

Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-2

Incentives and Labor Supply

• Joe Louis and Oscar de la Hoya are two of the greatest boxers ever

• Both fought longer than they should have– Louis fought because he had so little money– De la Hoya fought because he was offered so

much• Both Louis’s and de la Hoya’s actions can be linked

to labor supply


Learning Objectives

• Understand the basic model of wage determination in labor markets

• Be able to describe why the salaries of superstars are much higher than the salaries of average players

• Analyze the labor markets for individual sports, such as golf and tennis

• Explain why players use performance-enhancing drugs despite knowing their harmful effects


8.1 Labor Supply and Demand

• Figure 8.1 shows that in the last 20 years alone, the average salary of a Major League Baseball player has almost quadrupled– From about $850,000 to over $3.3 million

• To put this in perspective, the average MLB salary was approximately – 36 times per capita GDP in 1991– 65 times per capital GDP in 2011

• Salaries have risen similarly in other professional sports, both in the US and abroad


Figure 8.1


Labor Supply

• The supply curve has a slightly different character from the typical supply curve

• We usually see the price of a product on the vertical axis and the quantity of a product on the horizontal axis

• In labor markets, the price is the wage rate and the quantity is the number of hours a worker chooses to work

• The upward-sloping labor supply curve thus indicates that a worker responds to higher wages by offering more work time to employers– See Figure 8.2a


Figure 8.2a


Sports Application

• One can analyze team sports markets in several ways

• To analyze career length• Players have no say over work hours• The axes become salary per season and the number of

seasons

• To analyze the number of players hired in a season• The axes become salary per season and the number of

players willing to work at a given salary• See Figure 8.2b


Figure 8.2b


Boxing Application

– Fighters can choose how many fights they engage in • The axes become reward per fight and number

of fights• The boxing example in Figure 8.2b shows that a boxer

is induced to take on more fights as his pay increases– The player moves from point A to point B– This was the case for Oscar de la Hoya

• The supply for Joe Louis shifted because his savings/wealth was lower due to tax problems– He moved from point A to point A’


Labor Supply Analysis

• The work decision is a trade-off between income and leisure – Wage is the opportunity cost of leisure – As wages rise, leisure becomes more expensive– The substitution effect is away from leisure: As wages

rise, workers work more• But income rises with wages: with higher income,

workers can afford more of everything – The income effect is positive for leisure and negative

for work: Workers buy more leisure & work less• Typically, the substitution effect is stronger than the

income effect, so the supply curve slopes up


Labor Supply Curve

Prize money

S

Bouts

• De la Hoya made huge sums– His substitution effect

exceeded his income effect

– He fought more bouts– His labor supply curve

slopes up• Joe Louis made much less

– Why didn’t he fight less?


Moving the Labor Supply Curve

Wage S

L; H

S’

• Louis’s supply curve also sloped up

• But he had financial trouble– His income was

misappropriated He owed back taxes

• His wealth was very low– He could afford less of

everything, including leisure

– Less leisure means more labor

• His labor supply shifted right


Labor Demand

• To analyze labor demand, we consider the following simple scenario for firms– They produce a single output using two inputs, capital (K) – They operate in the short run (so capital is fixed) – They can alter output (Q) only by changing the labor input

(L)• We assume that all markets are perfectly competitive

– Firms cannot affect the market price of their output.– Firms maximize profit by choosing L to maximize profit

• Profit is the difference between revenue and cost: profit• It is maximized when marginal revenue (MR) from

employing one more worker equals the marginal cost of employing that worker (MC)


Marginal Revenue Product

• Marginal benefit of a unit of labor is a new concept– The extra worker produces extra output: Q/L =

MPL

– The output can be sold for additional revenue: MR– Marginal Revenue Product (MRP)=MR*MPL

– In competitive markets, MR = P, the market price– MRP = P x Q/L

• Marginal cost– Wage or salary (w)

• The firm maximizes profits when w=MR*MPL

• The MRP is the firm’s demand for labor: Figure 8.3


Labor Demand Curve

W

D

L

• Labor demand slopes down

– MPL falls as L rises

– So MRP also falls• Measuring MRP can be

complicated– What do players

produce?– How do individual

statistics relate to the team’s output?

– What is the market value of that output?


One Way to Measure Labor Demand in the NBA

• David Berri, Stacey Brook and Martin Schmidt (2006) claim: MRPij = MRwin*winsij

– MRPij = MRP of player i on team j

– MRwin = Revenue from 1 more win (~$1.67 M)

winsij = Added wins team j gets from player i

• They also claimwinsij = points + rebounds + steals + .5(blocks+

assists) – field goal attempts – turnovers – .5(free throws + personal fouls)


Do Teams Reward Performance?

• Berri found that LeBron James produced 17.3 wins in 2011-12– Most in the NBA (in a 62-game season)– Made him worth $28.9 Million to the Miami Heat– He was actually paid ~$17.5 Million

• The third most valuable player was Tyson Chandler– He scored only 11.3 points per game– But he produced 13.3 wins – worth ~$22.2 million– He was paid “only” $13.6 million

• Berri asserts that teams reward points more than performance


Imperfect Competition

• If we assume imperfection in the product market, then MR no longer equals the market price

• Recall that to sell another unit of output, the monopolist must sell all previous units at a lower price, so his MR curve is always below his demand curve– This is illustrated in Figure 8.4

• A monopolist hires fewer workers and pays lower wages than it would if the industry were competitive

• This is consistent with the fact that monopolists restrict output as part of their strategy to maximize profits


Figure 8.3


Figure 8.4


Labor Market Equilibrium

• The market demand curve is the summation of all individual demand curves– This is a summation over all teams in a league

• The market supply curves is the summation of all individual supply curves– This is a sum across all players

• See Figure 8.5


Figure 8.5


Impact of Growing Popularity

• Equilibrium is where demand and supply meet

• As the NBA became more popular in the 1970s– The value of players’

output rose– MR rose as ticket prices

did– Marginal product was

unchanged – Demand shifted right– Salaries rose and rosters

increased

w

S

D

L

e

e’

D’


The 2008 Recession

• The recession reduced revenues– Fans could not afford

tickets– Sponsors cut back on

marketing

• This reduced the value of output– Demand shifted left– Salaries fell

S

L

e

e’e”

D’D”

D

w


Effect on Rosters

• The standard analysis does not seem to apply to quantity

• Figures 8.5 and 8.6 imply that roster size rises in good times and falls in bad times– This does not happen

• Roster limits impose a vertical line at the set size– Salaries adjust as demand fluctuates– The quantity of players stays fixed– See Figure 8.7


Figure 8.6


Figure 8.7


Human Capital and Player Compensation

• Investment is a sacrifice that brings future gains• Investment is an increase in capital

– Firms invest in physical capital (plant & equipment)– Gary Becker introduced the theory of human

capital– People invest in human capital (embodied

knowledge or skills)– Attending college is one such investment– On-the-job training is another

• As human capital rises, so do MPL and wage

• Athletes acquire human capital like other workers


General Human Capital

• General skills of workers are useful to all employers– In sports, these skill are basic footwork, fielding,

and shooting– Workers can benefit from the general skills with

any employer– Workers can easily leave after receiving training

• If a worker leaves, the firm cannot recoup its investment in the worker’s general skills

• Thus, workers typically pay to acquire general skills – They pay in the form of lower salaries– This is one reason why minor leagues pay so little


Specific Human Capital

• Specific skills are useful to only one firm– Sports: How to play within a specific system or

team? • A worker with specific human capital cannot earn as

much elsewhere– He is less likely to leave– The firm can recoup its investment as the worker

is more productive and does not leave– The firm pays for much of investment in specific

skills


A Simple Example

• Assume a player’s career lasts two seasons

– He brings benefits MRP1 in period 1 and MRP2 in period 2

– The team sets w1 = MRP1 and w2 = MRP2

– If the team provides general skills to the player at cost T• The team’s costs in period 1 rise• The team cannot recoup cost T in period 2 or the player

leaves

• The team sets w1+ w2/(1+r) + T = MRP1 + MRP2/(1+r)

– r is the discount rate

– The fir reduces w1 – so the player “pays” for training

• If the skills are specific to the team, the firm reduces w2

– It has no problem


8.2 Tournaments and Superstars

• In 2009, Roger Federer barely beat Andy Roddick at Wimbledon– Gentlemen’s final: 5-7, 7-6, 7-6, 3-6, 16-14– If both players received their marginal product,

the two should have received almost identical prizes

– In fact Federer received twice as much (£750,000 v. £375,000)

– The winner of a tournament typically gets a huge prize regardless of the margin of victory

– The runner up gets half as much– Players eliminated early get virtually nothing


Rank Order Tournaments

• Tournaments are settings in which rewards are based on “rank order” – The rank order is a measure of relative

performance• Rewards are independent of the absolute level of

performance– This system of award is very common in settings

in which absolute performance is hard to determine

– The outcome depends on other factors, such as playing surface and weather


Rationale for Rewarding Rank

• We assume that participants maximize utility and that their utility increases with income and leisure and decreases with effort

• Marginal curve in Figure 8.8 shows that marginal cost of effort is positive rises at an increasing rate

• Marginal reward in Figure 8.9 must rise disproportionately to get effort to rise from E1 to E0

– Note that the tangent is a result of the same starting point


Why Use Rank Order?

• Paying workers their MRP is the best incentive– Pay improves with performance

• Firms usually do not pay workers their MRP– They pay workers by the hour, month, or year– It is often hard to measure MRP– It is costly or impossible to monitor workers

perfectly• It is usually much easier to tell whose MRP is bigger• Tournaments set up distinct rewards

– The winner receives much more than the loser– Increasing spread increases the incentive to win


Studies of Tournament Theory

• Ehrenberg and Bognanno applied it to golf– They showed that scores in the last round improved with

• The total prize money available• The reward to improving

– Moving from 2nd to 1st is more rewarding than going from 22n to 21st

• Do men and women respond differently?– Gneezy and Rustichini tested Israeli 4th graders

• Had them run alone and then in pairs• The girls ran slower in pairs than alone – the boys ran

faster in pairs– Gilsdorf and Sukhatme find no gender difference in tennis– Leeds and Leeds find female figure skaters respond more

to incentives than male skaters


Payment to Celebrities

• Superstars get most of the reward --see Table 8.1• The effect of success lingers

– Michael Jordan was among the highest earners long after he retired

• Athletes earn relatively little– Tiger Woods – the highest-ranked athlete—was 14th – The highest-paid female athlete, Maria Sharapova, was

72nd

• Executives are paid like celebrities– The salary of a top executive in a large corporation is

likely to be at least twice that of his or her nearest rival– Output of executives is hard to measure


Table 8.1


8.3 Tournaments and Cheating

• Is trying hard the only way to win? • Teamwork can be harmed

– Players can try to harm others’ performance– Shoot first, pass second

• Competitors might try to sabotage the performance of others


The Case of NASCAR

• NASCAR doesn’t want drivers to be too aggressive

• It fears the negative externalities of dangerous driving

• Too many accidents can reduce viewership and harm the sport

• Peter von Allmen notes a much flatter reward structure– Figure 8.10– Frick and Humphreys confirm that NASCAR

times improve as the prize spread increases


Figure 8.8


Figure 8.9


Figure 8.10


Too Much of a Good Thing

• High rewards put pressure on athletes and their coaches to succeed

• Children leave their families to train and may be abused

• Children are prohibited from working but not training

• Many young female athletes have very delayed puberty – They eat too little and work out too much– They endanger their bone structure later in life

• In some cases, the effort to lose weight has proven fatal


Performance-Enhancing Drugs (PEDs)

• We celebrate the athletes who use innovations– Experimental surgery that extends a career– New strokes and new suits that make them swim faster– New techniques that allow them to clear a higher high

bar• PEDs seem different from the above

– Many PEDs are dangerous, controlled substances– We do not know who is taking them– First known PED fatality was a bicyclist in 1879– In 1980s East German girls were given “vitamins”

• They were actually steroids and male hormones• Birth defects and medical & sexual side-effects

resulted


A Study of PEDs

• Humphreys and Ruseski find that 5.4% of high school boys used PEDs in 1991-2005

• This was roughly twice the rate of usage by girls• Humphreys and Ruseski found distinct patterns to

usage– Greater for multisport athletes– Less for youths with better-educated, wealthier

parents– Greater for those using other, non-enhancing

drugs


Doping as a Prisoner’s Dilemma

Mark doesn’t use PEDs Mark uses PEDs

Sam doesn’t Use PEDs

No advantage

No harm

Mark wins

Sam loses

Sam uses PEDs Mark loses

Sam wins

No advantage

Harm done

• Doping is the dominant strategy• Doping leads to a suboptimal outcome• Consider the outcome payoff matrix below


PEDs Have Tarnished Entire Sports

• Baseball has been particularly affected• The following news items have stood out

– Barry Bonds’ tainted home run title in 2007– Ryan Braun’s tainted MVP award in 2011– Melky Cabrera’s tainted batting title in 2012

• Track and Field has seen regular forfeits of gold medals– Marion Jones went from the podium to prison


PEDs and the Tour de France

• Cycling has been more affected than most sports

• Since 1998 doping has been linked to– 37% of all top 10 finishers– 80% of all winners

• Lance Armstrong has been stripped of his 7 titles


The Distribution of Income

• This is another application of the Lorenz Curve• Top performers are paid disproportionately

– Again, a slight edge leads to much greater pay• Consider the 2011 WTA women’s tennis tour

– The top 10 players won over 42% of the prize money

– Players ranked 91-100 received less than 3% – See Figure 8.11


Figure 8.11

Chapter 8 An Introduction to Labor Markets in Professional Sports FIFTH EDITION The Economics of...

Documents

Transcript of Chapter 8 An Introduction to Labor Markets in Professional Sports FIFTH EDITION The Economics of...