Labor Economics of Sports I: Wage Determination.
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Transcript of Labor Economics of Sports I: Wage Determination.
Labor Economics of Sports I:
Wage Determination
An Overview Smoothly functioning markets
Labor Supply and Labor Demand Is LeBron James underpaid?
Human Capital Monopsony and Free Agency Salary Arbitration Superstars and Winner-take-all When to turn pro?
What’s the difference between Tara Lipinski
And Funny Cide?
To see answer: Consider Labor Supply
Indifference curves• Show desires• Personal trade-off
• Goods vs. Leisure
x
L
To see answer: Consider Labor Supply
Indifference curves• Show desires• Personal trade-off
• Goods vs. Leisure
Constraint in 2 parts Exogenous Income (I)
• Vertical Segment Downward sloping
• Slope=wage (-w)
x
L
To see answer: Consider Labor Supply
Indifference curves• Show desires• Personal trade-off
• Goods vs. Leisure
Constraint in 2 parts Exogenous Income (I)
• Vertical Segment Downward sloping
• Slope=wage (-w)
Best off at tangency Best possible mix
x
LL*
Leisure
Work
T
What happens if I rises Pure income effect Moves straight up What causes this?
Leisure
Work
What happens if I rises Pure income effect
Can afford more of everything
Moves straight up What causes this?
Tara v. Funny Cide MoreLeisure
LessWork
Responses to changes What happens if w rises?
Constraint gets steeper Two effects
Substitution effect: • Leisure costs more• Work more• Longer careers in baseball
Income effect: • Can afford more of everything – including leisure• Oscar de la Hoya quits boxing
The Other Blade of Scissors The Demand for Labor
Firm weighs marginal costs & benefits Marginal benefit
Marginal Revenue Product=MR*MPL
Marginal cost Wage or salary (w)
Profits maximized when: w=MR*MPL
What happens to MPL when add workers? What happens to Demand when:
Workers become less productive? Output becomes more valuable?
Why did NBA salaries skyrocket in 1990s?
What is LeBron Worth? Simplify problem
Fixed Supply” of LeBron What sets wage? Demand!
w
SLJD
L
What drives demand? Attendance
Gate revenue up $5.3M in Cleveland Venue revenue
• Sponsorship revenue up 17% Media revenue
Local TV ratings up 265% Regional TV ratings up 231%
LeBron may be a bargain
Human Capital What is an investment? Can invest in people as well
Increase skills – why are you in college? General vs specific skills Worker pays for general skills
Firm cannot recoup investment Firm helps pay for specific skills
Firm can recoup investment• So why doesn’t it pay all?
Examples? A rationale for the reserve clause?
Monopsony Upside down Monopoly Lower wages Lower employment Deadweight loss Application to sports? Can you buy a suit from
Jim Thome? Might have 30 years ago
$
ME
S
D
L
wc
wm
Lm Lc
Monopsony and Baseball Early years marked by “thievery”
Nat’l Assn of Professional Base Ball Players Pittsburgh Pirates named for piracy of players
William Hulbert – a unique thief Steals 5 players from other clubs Calls for end to thievery
Forms National League of Baseball Clubs Key: Teams reserve 5 players Eventually extended to all players: Reserve Clause
Seemingly Innocent Reserves for length of contract
PLUS one year Key: Players not allowed to play
without a contract Recursive system keeps players stuck Other leagues copy – often verbatim
Free Agency All major sports have eliminated
Reserve Clause (later we’ll see how) Limits on Free Agency differ
NHL has many classes of free agency NFL allows teams to keep “franchise
player” – at a price Salary caps in NBA & NFL limit
movement
A-Rod and the Yankees Do rich teams get all the best players? The Yankees and Alex Rodriguez
Didn’t pursue him Pursued him
Why did they change their minds? Think Marginal Product
Ronald Coase and The Curse of the Bambino
Economists believe free agency overrated Were things different pre-free agency?
In 1920 Red Sox sold Babe Ruth to Yankees Connie Mack twice sold off championship teams
Key is the Coase Theorem First applied by Ronald Coase to pollution Don’t need government to solve an externality Just need well-defined property rights
The Idea of the Coase Theorem
Consider: pizza factory and a brewery Brewery’s fumes affect pizza makers
If Pizza factory has property rights Brewer compensates pizzeria Or reduces pollution
If Brewer has property rights Pizzeria compensates Brewer Or cuts back pollution
Result independent of rights Pollution – or its impact - reduced Only difference: who gets paid
The Coase Theorem and Free Agency
Free Agency does not affect talent Babe Ruth worth more in NY
Yankees paid owner of Red Sox in 1920 Now he would pay Babe Ruth
Players flow to most valued use Only difference is who gets paid Implications of Revenue Sharing?
Rank Order Tournaments Market bases reward on productivity
As productivity rises – so does reward Some rewards are discontinuous
Second by one stroke or ten? Senior VP vs CEO
Based on “rank order” in contest Not on actual contribution
Why Use Rank Order? Best to pay MRP
Incentives appropriate Equivalent to paying “piece rate”
Usually don’t pay “piece rate” Pay by hour, month, year Seems inefficient
Key: How to judge productivity?
Tournaments Stimulate Effort
Want workers to try hard Cannot always see how hard they try Easier to see who tries hardest Set up distinct rewards
Winner makes much more than loser Bigger spread gives greater incentive
Problems with Tournaments What if contest seems uneven?
Joe Louis & the “Bum of the Month” Participation and effort may fall
Is trying hard the only way to win? Tonya Harding whack, whack, whack Shoot first, pass second May compress wages to avoid sabotage
The Economics of Superstars
Like tournament – skewed rewards Disproportionate reward to being
best Who wants 2nd best surgeon?
Fixed supply Rationed by price
TV skews rewards Greater access to best Decline of minor leagues
P
S
D’
D
Q
Problems Caused by Superstar Effect
Little Girls in Pretty Boxes Eating disorders rampant –especially gymnasts
• 2/3 among college gymnasts – not even elite! Would violate labor laws – if paid Injuries go untreated
• “Would lose muscle tone” in cast
Faust’s Gold East German girls given “vitamins” Birth defects, medical and sexual side-effects
What about the boys? Some want to be big: BALCO scandal Some want to be small: jockeys and tapeworms
Measuring Inequality Does free agency affect salary distribution?
Measure with Lorenz Curve Compares population with income
To see line up by income (Excel) Fish-eye increases with inequality
What do absolute equality/inequality look like? Problem: Curve is hard to interpret Gini Coefficient: a more precise measure
Ratio of fish-eye to triangle Has risen with Free Agency in all sports
Arbitration A way to deal with disputes Mediation – play the middleman Arbitration – play the judge
Binding vs non-binding Danger of arbitration
Can be addictive Must consider motives of arbitrator
The Problem with Arbitration Arbitrator likes job Doesn’t want to offend
either side Chooses middle Lose incentive to
compromise Arbitration “addictive”
Labor Firm
Arbitrator
Final Offer Arbitration Each side makes final offer
Arbitrator must choose one Restores incentive to compromise Problem with practice in baseball
Ignores ½ the market Can consider only credentials & peers Worse than free agency
Ripple effect of others’ errors
When to Turn Pro? When to cut down tree or sell wine? Key tradeoff for all three the same:
Waiting => lose current income Selling => miss out on higher value
Consider LeBron James If went to college: Would improve skills But: Would delay earnings
• For simplicity assume career length fixed Risk may also play a role
• Insurance as scouting report
A Simple Decision Rule Simplifying assumptions
Earns S if turn pro right away• Ignore uncertainty or risk of injury
Skills & earnings rise at rate g in school• Would earn (1+g)S if wait one year
Earnings worth less in one year• Interest rate = r• Present value of waiting:
LeBron stays in school if g>r Turns pro if g<r
Sr
g
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