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Welcome to The Economics of Sports! Why study sports economics? Sports and recreation industry is a big business. PRE: Plunkett Research, Ltd. Why study sports economics? Sports and recreation industry is a big business. Sports face unique industry/firm specific issues

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Welcome to the economics of sports l.jpg

Welcome to The Economics of Sports!


Why study sports economics l.jpg

Why study sports economics?

  • Sports and recreation industry is a big business.


Slide3 l.jpg

PRE: Plunkett Research, Ltd.


Why study sports economics5 l.jpg

Why study sports economics?

  • Sports and recreation industry is a big business.

  • Sports face unique industry/firm specific issues

  • Sports is popular and invokes emotion/fervor.

  • Sports is full of myths and mistaken intuition. Often people confuse correlation with causation, which economics hopes to help correct.

  • It is often a useful vehicle for indirect inference in other industries.


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Overview of Course

  • Review of Basic Economics

    • Will largely assume you know this

  • Industrial Organization

    • Do Teams/Leagues Maximize Profits?

    • Do/Should Antitrust Laws Apply?

  • Public Finance

    • Why/how do cities finance facilities?

  • Labor

    • Why Do Athletes Make So Much?

    • Unions & Discrimination

  • The NCAA, the Olympics, and Amateur Sports


Economics review l.jpg

Economics Review

  • Economics is the study of choices under constraints

  • Who makes choices?

    • Households

    • Firms

    • Governments

  • We try to model decisions in simplified frameworks to isolate the issues that influence decision making.


Market model l.jpg

Market Model

  • Demand shifters

    • Income

    • Price of related goods

    • Consumer tastes

    • Market size

    • Price expectations

  • Supply shifters

    • Input prices

    • Technology

    • Taxes

    • Price expectations

    • Number of firms

$

S1

P1

D1

Q1

quantity


Price elasticity l.jpg

Price Elasticity

  • Measure of price sensitivity

  • Elastic demand: |E| > 1

  • Inelastic demand: |E| < 1

  • More substitutes

  • Big budget items

  • Longer time horizons


Elasticity l.jpg

Elasticity…

TR = $50,000

$

E = ?

50

TR = $48,000

40

D1

tickets

1000

1200


Price controls l.jpg

Price Controls

  • Price Ceilings

    • create shortages

    • create black markets

S1

P1

Pceiling

D1

Q1

Qd

tickets

shortage


Price controls12 l.jpg

Price Controls

  • Price Floors

    • Create surpluses

S1

Pfloor

P1

D1

Qd

Q1

tickets

surplus


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Maximizing Profit

  • Profits = p = TR - TC

  • Profit-max rule: MR = MC

  • What do the NY Yankees sell?

  • What kind of cost is Alex Rodriguez’s salary?


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Perfect Competition

  • Assumptions

    • Many small sellers/buyers

    • Homogeneous product

    • Free entry/exit

    • Perfect information

       firms are price takers


Perfect competition15 l.jpg

Perfect Competition

MC

$

S

ATC

MR = P

P1

D

q1

Q1

Quantity

Market

Firm


Monopoly l.jpg

Monopoly

  • Relevant Market

    • Any close substitutes?

  • Entry Barriers

    • Economies of scale

    • Control over key input

    • Government restrictions


Monopoly17 l.jpg

Monopoly

Profits are maximized

where MR = MC

Price is set off of demand

curve

$

MC

ATC

P1

ATC1

D

Quantity

Q1

MR


Pricing strategy phillies vs flyers l.jpg

Pricing Strategy: Phillies vs Flyers

  • Each is a monopoly

  • MC a backward “L”

  • Does it pay to sell out?

$

MC2

MC1

P2

P1

Q1

D

MR

Citizens Bank Park

43,500

Wachovia Center

19,500


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2006 Ticket Prices

Source: philadelphia.phillies.mlb.com and philadelphiaflyers.com


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The Role of Uncertainty

  • Are the Yankees bad for baseball?

    • Are dynasties a bad idea?

    • How often should the home team win?

  • Why do teams sell season tickets?

    • Transfers risk from team to fans

    • Why do fans buy them?


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Attendance vs Winning Pct.

NFL

MLB


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Can Losing be Good?

  • Cleveland Browns won all the time in AAFC

  • Fans of AAFC lost interest

    • Even Browns fans

    • Attendance fell

  • Attendance fell in MLB in 1950s

    • NY teams in every World Series (sort of)

    • Why go see Pittsburgh play Cincinnati?

  • Study looked at attendance in MLB

    • Controlled for day, time, weather, quality of opponent

    • Attendance highest when home team won 60% of time


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Regression Analysis

  • Regression is a form of statistical analysis of economic behavior and theory.

    • Regression analysis attempts to explain the variance of a particular variable of interest.

  • Attendance Function

    A = f(X1, X2, X3, …)


Regression example l.jpg

Regression Example

  • Consider a model of baseball attendance. We think that the following items might influence overall team attendance in the following ways

A = β0 + β1P + β2POP + β3C + β4I + β5QH + β6QV + β7W


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  • Here are some actual regression results from Depken (2000, Journal of Sports Economics)


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Franchise Economics and Owner Objectives


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Franchise Objectives

  • Maximize profits?

    Profit = TR – TC

  • Championships?

    • Bad things can happen if bottom line is forgotten

    • Case in point: Ottawa Senators

      • Best record in NHL: 2002-2003

      • Declared bankruptcy: 2003

  • Ego premium?

  • Civic-mindedness?


  • Franchise revenues l.jpg

    Franchise Revenues

    TR = RG + RB + RL + RS

    • Where:

      • RG = Gate Revenue

      • RB = Broadcast Revenue

      • RL = Licensing Revenue

      • RS = Stadium Revenue


    Gate revenues r g l.jpg

    Gate Revenues: RG

    NFL:  = 60%

    MLB:  = 66%

    NBA, NHL:  = 100%

    RG = Rh + (1- )Rp

    •  = home team’s share

    • Rh = home team gate

    • Rp = pooled gate from all other teams

  • Impact of Revenue Sharing

    • Financial stability (early NFL struggled to maintain league); "luxury tax" in MLB

    • Competitive balance

    • Shifts funds from teams that spend a lot on good players to teams that do not; tends to depress what teams are WTP for players (“tax on quality”)


  • Broadcast revenue r b l.jpg

    Broadcast Revenue: RB

    • National revenue is shared equally

    • Local revenue is not shared equally

      • KC: A small market for MLB but not NFL

      • Green Bay would have disappeared

    • Tradeoff: RB vs RG?

       blackouts

    • What determines broadcast rights payments?

      • Demand by Advertisers

      • Super Bowl XLIII:

        • NBC received $206m for 69 spots ($3m per 30 seconds)


    Slide31 l.jpg

    Broadcast Money Trail


    Slide32 l.jpg

    Source: various sources


    Stadium revenue r s l.jpg

    Stadium Revenue: RS

    • Concessions

    • Parking

    • Naming rights: pros; colleges; individuals

    • Luxury seats

      • don't count as gate, therefore, don't have to share

    • Example:

      • luxury suite rents for $500,000 per year

      • 20 seats

      • claim each seat is worth $50

      •  team must share $3200 = 0.4 * 20 * $50 * 8 games


    Why have we seen a move to small markets by nfl teams l.jpg

    Why have we seen a move to small markets by NFL teams?

    • Rams: LA  St. Louis

    • Raiders: LA  Oakland

    • Oilers: Houston  Nashville

    • Browns: Cleveland  Baltimore

    Revenue Sharing is the key!


    Licensing revenue r l l.jpg

    Licensing Revenue: RL

    • Generally shared with all teams

    • Cowboys broke ranks with NFL in 1995 by signing Pepsi for stadium sponsorship


    Franchise costs l.jpg

    Franchise Costs

    + OC

    TC = CP + CA + CT + CS

    • Player Salaries

      • Over 50% of team revenues

      • Deferred compensation

      • Bonuses

      • Workers’ comp

      • Pension contributions

      • Player Development

        • MLB and NHL

    • Administrative

      • Coaches and management

      • Marketing

    • Travel

    • Stadium

    Opportunity Costs: Profit that could be earned in another city


    Average costs and revenues in millions across the major sports in 2006 l.jpg

    Average costs and revenues (in millions) across the major sports in 2006


    Accounting games l.jpg

    Accounting Games

    • Book Profit and Depreciation

      Profit = TR – TC

      • Corporate taxes depend on book profit

        • Paying high administrative costs reduces book profit

        • Interest is tax deductible (dividends are not)

        • Player contracts are treated as depreciable assets

          • Bill Veeck

          • San Antonio Spurs example

    Costs include interest expenses

    and depreciation of capital


    Slide39 l.jpg

    Table C

    San Antonio Spurs Depreciation and Tax Savings 1993-4/1994-5

    (All figures in $millions)


    Accounting games40 l.jpg

    Accounting Games

    • Vertical Integration

      • Media outlet buys sports team

        • AOL Time Warner  Atlanta Braves

        • Tribune Company  Chicago Cubs

        • Disney  Anaheim Angels /Anaheim Ducks

        • FOX  LA Dodgers

      • Double monopoly?


    Slide41 l.jpg

    Downstream Firm

    (Network)

    Upstream Firm

    (Team)

    Pdown

    • Vertically integrated firm sets transfer price to allocate profit across combined entity

      • Set low broadcast rights fee to reduce team profits in order to plead poverty during lobbying for public subsidy

    MC

    Pup

    MC

    D

    D

    MR

    MR

    Qup

    Qdown


    League decisions l.jpg

    League Decisions

    • Cincinnati Red Stockings (1869)

      • “barnstorming”

    • National League (1876)

      • $0.50 tickets

      • No Sunday games

      • No beer

    American Association (1882)

    $0.25 tickets on Sunday with beer!


    League decisions43 l.jpg

    League Decisions

    • Setting the Rules

      • # games, game format, equipment

    • Limiting Entry

      • Teams

        • Benefits:

          • Entry fee

          • More revenue sources

        • Costs:

          • Sharing of league revenues

          • Reduced geographical monopoly

          • Reduces threat of moving

      • New leagues: ABA, WHA, AFL, USFL

    • League-wide Marketing

      • Free-rider problem

    • Competitive Balance and Revenue Sharing


    If a team always sells out its home games economists would say it is very likely that l.jpg

    If a team always sells out its home games, economists would say it is very likely that:

    • A surplus exists

    • There is excess supply

    • There is excess demand

    • Prices are too high


    If an industry is a monopoly output is and prices are than if it were perfectly competitive l.jpg

    If an industry is a monopoly, output is _____ and prices are _____ than if it were perfectly competitive.

    • Lower, lower

    • Higher, lower

    • Lower, higher

    • Higher, higher


    If demand for tickets to see the la lakers is inelastic l.jpg

    If demand for tickets to see the LA Lakers is inelastic,

    • Fans will respond to a price increase with a proportional decrease in quantity demanded.

    • fans will respond to a price increase with a less than proportional decrease in quantity demanded.

    • fans will respond to a price increase with an infinitely large decrease in quantity demanded.

    • fans will respond to a price increase with a more than proportional decrease in quantity demanded.


    If income increases and tickets to see a notre dame football game are a normal good then the l.jpg

    If income increases and tickets to see a Notre Dame football game are a normal good then the

    • demand for tickets will decrease.

    • supply of tickets will increase.

    • demand for tickets will increase.

    • supply of tickets will decrease.


    The fact that attendance rises at baseball stadiums during bobblehead days suggests l.jpg

    The fact that attendance rises at baseball stadiums during “bobblehead” days suggests

    • baseball games and bobbleheads are complements.

    • baseball games and bobbleheads are substitutes.

    • baseball games and bobbleheads are normal goods.

    • No information about baseball games and bobbleheads can be determined from this fact.


    A negative aspect of anti scalping laws is l.jpg

    A negative aspect of anti-scalping laws is

    • they prevent sell-outs.

    • they cause people to pay more than they are willing to in order to get tickets.

    • they prevent the market from matching willing buyers and sellers.

    • they hurt ticket agencies.


    If the knicks sign lebron james to a big contract they may raise ticket prices because l.jpg

    If the Knicks sign LeBron James to a big contract they may raise ticket prices because

    • their average cost curve shifts up.

    • their demand curve shifts right.

    • their marginal cost curve shifts up.

    • their fixed cost curve shifts up.


    If a game is not sold out then the marginal cost to a team of accommodating one additional fan is l.jpg

    If a game is not sold out, then the marginal cost to a team of accommodating one additional fan is

    • almost infinite.

    • about equal to the team's payroll

    • essentially zero.

    • about half the cost of a ticket.


    To determine the market demand for tickets to see the boston bruins play hockey we l.jpg

    To determine the market demand for tickets to see the Boston Bruins play hockey we

    • add the marginal revenue at each price.

    • divide the revenue of the team by the number of fans.

    • add the price consumers are willing to pay at each quantity.

    • add the quantity demanded at each price.


    The league with the most equal split of gate receipts between the home and visiting teams is l.jpg

    The league with the most equal split of gate receipts between the home and visiting teams is

    • The NFL

    • The NBA

    • Baseball’s National League

    • The NHL


    The naming rights curse refers to the fact that l.jpg

    The "naming rights curse" refers to the fact that

    • teams that have sold their naming rights have performed poorly.

    • teams often receive too little revenue for their naming rights.

    • cities generally do not receive any of the naming rights revenue.

    • firms that have bought naming rights have often run into financial difficulties.


    Over the course of a single season the largest proportion of team cost is l.jpg

    Over the course of a single season, the largest proportion of team cost is

    • zero.

    • fixed.

    • variable.

    • shared by all teams in the league.


    The ownership of professional teams by media outlets l.jpg

    The ownership of professional teams by media outlets

    • prevents cross subsidization.

    • is known as horizontal integration.

    • is known as vertical integration.

    • is becoming less common.


    The dallas cowboys are such a valuable franchise because they l.jpg

    The Dallas Cowboys are such a valuable franchise because they

    • can tap into both U.S. and Mexican media markets.

    • have a tradition of winning that attracts fans from all over.

    • have done an expert job of managing the salary cap.

    • have so many luxury boxes.


    By declaring subchapter s status owners of professional teams can l.jpg

    By declaring Subchapter S status owners of professional teams can

    • increase their revenue flow and hence their profits.

    • reduce the Corporate Tax Rate that they must pay.

    • use depreciation to reduce their personal taxes.

    • reduce the interest payments they must make to their creditors.


    Marketing for a league is a public good if l.jpg

    Marketing for a league is a public good if

    • all teams pay for the cost of advertising for small market teams.

    • all teams pay an equal share of the cost of advertising campaigns.

    • all teams derive benefit from an advertising campaign.

    • all teams pay some share of the cost of advertising campaigns.


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