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Welcome to The Economics of Sports!

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  1. Welcome to The Economics of Sports!

  2. Why study sports economics? • Sports and recreation industry is a big business.

  3. PRE: Plunkett Research, Ltd.

  4. 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.

  5. 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

  6. 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.

  7. 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

  8. Price Elasticity • Measure of price sensitivity • Elastic demand: |E| > 1 • Inelastic demand: |E| < 1 • More substitutes • Big budget items • Longer time horizons

  9. Elasticity… TR = $50,000 $ E = ? 50 TR = $48,000 40 D1 tickets 1000 1200

  10. Price Controls • Price Ceilings • create shortages • create black markets S1 P1 Pceiling D1 Q1 Qd tickets shortage

  11. Price Controls • Price Floors • Create surpluses S1 Pfloor P1 D1 Qd Q1 tickets surplus

  12. 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?

  13. Perfect Competition • Assumptions • Many small sellers/buyers • Homogeneous product • Free entry/exit • Perfect information  firms are price takers

  14. Perfect Competition MC $ S ATC MR = P P1 D q1 Q1 Quantity Market Firm

  15. Monopoly • Relevant Market • Any close substitutes? • Entry Barriers • Economies of scale • Control over key input • Government restrictions

  16. Monopoly Profits are maximized where MR = MC Price is set off of demand curve $ MC ATC P1 ATC1 D Quantity Q1 MR

  17. 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

  18. 2006 Ticket Prices Source: philadelphia.phillies.mlb.com and philadelphiaflyers.com

  19. 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?

  20. Attendance vs Winning Pct. NFL MLB

  21. 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

  22. 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, …)

  23. 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

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

  25. Franchise Economics and Owner Objectives

  26. 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?

  27. Franchise Revenues TR = RG + RB + RL + RS • Where: • RG = Gate Revenue • RB = Broadcast Revenue • RL = Licensing Revenue • RS = Stadium Revenue

  28. 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”)

  29. 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)

  30. Broadcast Money Trail

  31. Source: various sources

  32. 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

  33. 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!

  34. Licensing Revenue: RL • Generally shared with all teams • Cowboys broke ranks with NFL in 1995 by signing Pepsi for stadium sponsorship

  35. 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

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

  37. 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

  38. Table C San Antonio Spurs Depreciation and Tax Savings 1993-4/1994-5 (All figures in $millions)

  39. 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?

  40. 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

  41. 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!

  42. 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

  43. 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

  44. 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

  45. 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.

  46. 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.

  47. 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.

  48. 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.

  49. 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.