Cubs 1914 club seating chart

The economics of sporTs

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The economics of sporTs

F i f t h E d i t i o n

Michael A. Leeds Temple University

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Library of Congress Cataloging-in-Publication Data Leeds, Michael (Michael A.) The economics of sports/Michael A. Leeds, Peter von Allmen.— 5th ed. p. cm. ISBN-13: 978-0-13-302292-6 ISBN-10: 0-13-302292-7 1. Sports—Economic aspects. I. Allmen, Peter von. II. Title. GV716.L44 2013 338.4’3796—dc23

2012032292

ISBN-10: 0-13-302292-7 ISBN-13: 978-0-13-302292-6

10 9 8 7 6 5 4 3 2 1

For Daniel, Melanie, Dan, Tom, and Eric, who make everyday a treasure.

BRIEF CONTENTS

Preface xvii

Part 1 Introduction and review of Economic Concepts 1

Chapter 1 Economics and Sports 3

Chapter 2 Review of the Economist’s Arsenal 13

Part 2 the Industrial Organization of Sports 61 Chapter 3 Sports Franchises as Profit-Maximizing Firms 63

Chapter 4 Monopoly and Antitrust 111

Chapter 5 Competitive Balance 151

Part 3 Public Finance and Sports 181 Chapter 6 The Public Finance of Sports: Who Benefits

and How? 183

Chapter 7 The Public Finance of Sports: Who Pays and Why? 219

Part 4 the Labor Economics of Sports 249 Chapter 8 An Introduction to Labor Markets in Professional

Sports 251

Chapter 9 Labor Market Imperfections 289

Chapter 10 Discrimination 323

Part 5 Sports in the Not-for-Profit Sector 357 Chapter 11 The Economics of Amateurism and College

Sports 359

Works Cited 399

Photo Credits 423

Index 425

viii

CONTENTS

Preface xvii

Part 1 Introduction and review of Economic Concepts 1

Chapter 1 ECONOmICS aNd SPOrtS 3 Introduction 3

1.1 The Organization of the Text 4

Special Features and Additional Resources 5

1.2 Babe Ruth and Comparative Advantage 6

Opportunity Costs 6

Absolute and Comparative Advantage 7 ■ Biographical Sketch: Babe Didrikson Zaharias 9

Summary 11  •  Discussion Questions 11 •  Problems 12

Chapter 2 rEvIEw OF thE ECONOmISt’S arSENaL 13 Introduction 13

Learning Objectives 13

2.1  The Supply and Demand Model 14

Demand, Supply, and Equilibrium 14

Changes in Supply and Demand 17

2.2 Producing Output and the Production Function 27

A Note on the Definition of Output 27

The Production Function 27

Price Ceilings and the Economics of Scalping 30

2.3   Market Structures: From Perfect Competition to  Monopoly 32

Perfect Competition 32

Monopoly and Other Imperfectly Competitive Market Structures 34

The Impact of an Increase in Costs 37

2.4  The Rise of Professional Sports 39 ■ Biographical Sketch: Silvio Berlusconi 41

Summary 43  •  Discussion Questions 44 •  Problems 44

ix

x Contents

Appendix 2a UtILIty FUNCtIONS, INdIFFErENCE CUrvES, aNd BUdgEt CONStraINtS 45 2A.1  Constrained Maximization 45

2A.2   Using Indifference Curves and Budget Constraints:  The Rise of Soccer and Baseball 52

Appendix 2B rEgrESSION aNaLySIS IN BrIEF 54 Multiple Regression and Dummy Variables 59

Part 2 the Industrial Organization of Sports 61

Chapter 3 SPOrtS FraNChISES aS PrOFIt-maxImIzINg FIrmS 63 Introduction 63

Learning Objectives 64

3.1  Maximizing Profits or Maximizing Wins? 65

Maximizing Profit 66

Maximizing Wins 67

3.2  A Closer Look at Revenues, and Costs 68

A Detailed Look at Revenue 71

The Distributional Effects of Revenue Sharing 82

Cost 84

Opportunity Cost and Team Movement 85

3.3  Taxes, Profit, and Owner Behavior 86

Finding Profit in Losses 86

Operating Income, Taxes, and Profit 88

Vertical Integration 88

3.4 The Importance of Leagues 90

The Origin of Leagues in American Sports 91

Setting the Rules 92

Limiting Entry 94

Limited Entry as Cooperative Behavior 98

Advertising 98 ■ SportS and the law: The Limits of Leagues 101

3.5  Soccer’s Alternative Business Model 102

Profit-Maximization in Soccer 103

The Impact of Promotion and Relegation 104

The Financial Dangers of an Open System 106

The Single-Entity Ownership Model 106

Contents xi

■ Biographical Sketch: Bill Veeck 107 Summary 108  •  Discussion Questions 109 •  Problems 109

Chapter 4 mONOPOLy aNd aNtItrUSt 111 Introduction 111

Learning Objectives 112

4.1  What’s Wrong with Monopoly? 112

Monopolists and Deadweight Loss 112

Do Monopolies Always Charge Monopoly Prices? 115

Promotion, Relegation, and Monopoly Power 116

4.2  Strategic Pricing and Price Discrimination 117

Variable and Dynamic Ticket Pricing 117

Bundling 120

Price Discrimination and Two-part Pricing 121

Monopoly Stood on Its Head: A Brief Introduction to Monopsony 124

4.3  What’s Right with Monopoly? 125

4.4 Barriers to Entry that Leagues Create 127 ■ SportS and the law: Franchise Location 128

4.5   Society’s Response to Monopoly and Monopsony:  Antitrust Laws 129

An Important Anomaly: Baseball’s Antitrust Exemption 130

Leagues That Lack an Antitrust Exemption 134

Limited Exemptions: The NFL and Television 135

4.6  The NCAA: An Incidental Cartel 136

4.7   Prisoner’s Dilemma: How Rational Actions Lead to Irrational  Outcomes 139

■ Biographical Sketch: Alvin “Pete” Rozelle 142 Summary 144  •  Discussion Questions 145 •  Problems 145

Appendix 4a OvErvIEw OF BaSIC gamE thEOry 146 An Alternative Application of Game Theory 147

Chapter 5 COmPEtItIvE BaLaNCE 151 Introduction 151

Learning Objectives 152

5.1  Why Fans and Owners Want Competitive Balance 152

The Fans’ Perspective 152

xii Contents

The Owners’ Perspective 153

The Effect of Market Size 154

The Influence of Diminishing Returns 156

A Brief History of Competitive Balance 157

5.2  Measuring Competitive Balance 158

Within-Season Variation 158

Between-Season Variation 162

Illustrating Competitive Imbalance 164

5.3  Attempts to Alter Competitive Balance 167

The Invariance Principle 167

Revenue Sharing 169

Salary Caps and Luxury Taxes 171

The Reverse-Order Entry Draft 173

Schedule Adjustments in the NFL 176

Promotion and Relegation 176 ■ Biographical Sketch: Bud Selig 177

Summary 178  •  Discussion Questions 179 •  Problems 179

Part 3 Public Finance and Sports 181

Chapter 6 thE PUBLIC FINaNCE OF SPOrtS: whO BENEFItS aNd hOw? 183 Introduction 183

Learning Objectives 184

6.1  How Teams Benefit from New Facilities 184

Facilities, Attendance, and Profits 185

6.2  How Fans Benefit from a New Facility 187

The Size and Shape of Baseball and Football Stadiums 188

The Size and Shape of Basketball and Hockey Arenas 194

Do New Facilities Create Better Teams? 196

Teams as Public Goods 197

6.3  How Cities Benefit from Teams, Facilities, and Events 199

Positive and Negative Externalities 200

Facilities, Spending, and Tax Revenue 203

Location, Location, Location 211

The Impact of Special Events 212

Contents xiii

■ Biographical Sketch: Al Davis 215 Summary 217  •  Discussion Questions 217 •  Problems 217

Chapter 7 thE PUBLIC FINaNCE OF SPOrtS: whO PayS aNd why? 219 Introduction 220

Learning Objectives 220

7.1  How Cities Came to Fund Stadiums 220

Teams on the Move 221

The Three Eras of Stadium Construction 222 ■ SportS and the law: Who Can Move? 223

7.2  How Teams Exploit Monopoly Power 224

Leagues, Cities, and Market Power 225

The Winner’s Curse 229

7.3 Stadium Location and Costs 230

How Exchange Rates Affect Costs 231

Why Most Stadiums Are Not in the Center of Town 232

7.4 Stadium Costs and Financing 234

7.5 Paying for Stadiums 237

Who Pays a Sales Tax? 240

Incremental Financing 242

Taxes That Spread the Burden 243

The Benefits of Debt 243 ■ Biographical Sketch: Williard “Mitt” Romney 246

Summary 247  •  Discussion Questions 248 •  Problems 248

Part 4 the Labor Economics of Sports 249

Chapter 8 aN INtrOdUCtION tO LaBOr markEtS IN PrOFESSIONaL SPOrtS 251 Introduction 251

Learning Objectives 253

8.1  An Overview of Labor Supply and Labor Demand 253

Labor Supply 254

Labor Demand 256

Labor Market Equilibrium 261

8.2 The Economics of Tournaments and Superstars 265

xiv Contents

8.3   Tournaments, Cheating, and the Distribution of  Income 269

More Potential Pitfalls of High Rewards: The Case of NASCAR 270

Too Much of a Good Thing 272

Performance-Enhancing Drugs 273

The Distribution of Income 277 ■ Biographical Sketch: Scott Boras 278

Summary 280  •  Discussion Questions 280 •  Problems 281

Appendix 8a thE LaBOr–LEISUrE ChOICE mOdEL OF INdIFFErENCE CUrvES 282

The Labor–Leisure Model When Hours Are Fixed 286

Chapter 9 LaBOr markEt ImPErFECtIONS 289 Introduction 289

Learning Objectives 290

9.1  The Monopsony Power of Sports Leagues 290

The Economics of Monopsony 290

The Reserve Clause 292

9.2  Unions in Professional Sports 293

A Brief Introduction to the Economics of Unions 294

■ SportS and the law: McNeil v. The National Football League 299

Salary Arbitration 302

Measuring Monopsony Power 303

Salary Caps 304

Luxury or Competitive Balance Taxes 308

The Impact of Rival Leagues 309

9.3   Labor Conflict and Compromise in Collective  Bargaining 311

Comparing the 2011 NBA and NFL Negotiations 315

Professional Tennis Associations 318 ■ Biographical Sketch: Marvin Miller 320

Summary 321  •  Discussion Questions 322 •  Problems 322

Contents xv

Chapter 10 dISCrImINatION 323 Introduction 323

Learning Objectives 324

10.1  Becker’s Theory of Labor Discrimination 326

10.2   Different Forms of Discrimination in Professional  Sports 327

Employer Discrimination 327

Does Anyone Win with Employer Discrimination? 332

Employee Discrimination 337

Consumer Discrimination 340

Discrimination by National Origin in European Soccer 342

Positional Discrimination or Hiring Discrimination 344

Gender Equity—A Special Case? 348

10.3  Title IX and Discrimination in College Sports 349 ■ Biographical Sketch: Branch Rickey 352

Summary 354  •  Discussion Questions 354 •  Problems 355

Part 5 Sports in the Not-for-Profit Sector 357

Chapter 11 thE ECONOmICS OF amatEUrISm aNd COLLEgE SPOrtS 359 Introduction 359

Learning Objectives 360

11.1  The Troublesome Concept of Amateurism 360

A Brief History of Amateurism and the Olympic Ideal 360

11.2  The Costs and Benefits of College Athletics 366

The Revenue from Intercollegiate Athletics 366

The Revenue from Bowl Games 369

The Cost of Intercollegiate Athletics 373

Do Colleges Profit from Athletics? 375

Spillovers from Athletics to the University 376

11.3  The Role of the NCAA 380

The NCAA as a Regulatory Agency 380

The NCAA as a Club 382

xvi Contents

The NCAA as a Cartel 383

Academic Standards: A Basis of Academic Integrity or Monopoly Power? 387

11.4  The Returns to the Athlete 389

Pay for Play: The Grant-in-Aid 389

Measuring the Net Value of Athletes to Colleges 391

College as an Investment for the Student-Athlete 391 ■ Biographical Sketch: Anita Defrantz 396

Summary 397  •  Discussion Questions 398 •  Problems 398

Works Cited 399

Photo Credits 423

Index 425

PREFACE

As The Economics of Sports reaches its fifth edition, it is interesting for us to reflect back on the almost fifteen years since we began work on the first edition. When the first edition was published, the field was relatively new but rapidly growing. Undergraduate sports economics courses were popular, but not widely offered. Today, sports economics stands as a vital subdiscipline within applied micro- economics, with new and exciting research being produced by economists from around the world. Along with the increased research, the number of sports eco- nomics courses has grown as well. Throughout this process of growth and change, sports economics continues to serve as both a mirror and a lens, reflecting our broader culture and values, while at the same time bringing into focus such fun- damental issues as fairness and the legitimacy of free markets. With the passing of each season, new events unfold in professional and amateur sports that deserve analysis and explanation. Finally, in the context of this book, sports economics remains a vital and interesting area of study for students of economics. Sports provides a seemingly endless set of examples from every area of microeconomics, giving students the opportunity to study public finance, industrial organization, and labor markets in a context that holds student interest like no other industry.

Over the many years that we have worked on this project, we have enjoyed continuous help and support from students and colleagues at colleges and univer- sities across the United States and around the world. Our colleagues continue to offer encouragement, share classroom experiences, and suggest new and different coverage as the industry evolves. For all of this support and help, we are most grateful. And as we have said many times, we hope that our own enthusiasm, as well as the enthusiasm others have shared with us, is reflected in the text.

In recent years, many outstanding books that concentrate on specific sports or particular aspects of the economics of sports have been published. This text stands apart from the others in that it has the instruction of economic concepts as its central focus. We hope you find it useful and interesting.

new to thiS edition

The fifth edition represents our most comprehensive revision and update of the text since the first edition appeared in 2001. In doing so, we have retained the fea- tures from previous editions that made learning about sports economics meaning- ful as well as enjoyable, while at the same time incorporating many recent events in the sports industry and the broader economy.

• We have introduced a new feature for the fifth edition: Sports and the Law. Though we discuss the important decisions that have shaped the sports industry throughout the text, we’ve chosen four specific cases that particu- larly highlight the profound impact of the law in this industry. You will find these features in Chapters 3, 4, 7, and 9.

xvii

xviii Preface

• Chapter 2 now contains a full review of production theory in the context of team rosters as well as a review of the relationship between marginal prod- uct and marginal cost.

• Chapter 3 has been rearranged to highlight the differences between profit- maximization and win maximization as owner strategies. It also places greater emphasis on the role of the theory of clubs as an explanation for the recent turmoil in intercollegiate athletic conferences.

• We have supplemented our presentation of advanced profit-maximizing strategies with a discussion of dynamic ticket pricing, including a compari- son to variable ticket pricing and ticket bundling.

• The most significant change for this edition is the reorganization of Chapters 6 and 7. Chapter 6 now covers the benefits of public support for stadiums and events such as the Olympics to owners, fans, and cities. Chapter 7 covers the economics of financing these facilities and events. While much of the discus- sion that users liked from previous editions has been retained, the new orga- nization should lead to improved student understanding.

• Chapter 9 has been revised to provide a comprehensive explanation of the process and outcomes of the new collective bargaining agreements in the NBA and NFL.

• We have integrated Chapter 11 more fully into the rest of the book by emphasizing such concepts as profit-maximization and spillovers that appear elsewhere. This allows us to show more clearly how athletic depart- ments resemble—and do not resemble—professional sports teams.

As with the previous editions, our goal for the fifth edition is to keep the text comprehensive yet accessible. The text is designed to serve as the foundation for undergraduate courses in sports economics. The nature of the subject matter makes this a unique challenge. Unlike area courses such as industrial organiza- tion or labor economics, which are self-contained fields in the broader area of economics, sports economics cuts across a wide array of economic disciplines. To deal with this problem, we have split the text into five parts, three of which are devoted to illustrating prominent areas of economics: industrial organiza- tion, public finance, and labor economics. We hope that this division provides students with an overview of much of economics and inspires them to pursue each field in its own right. Because we focus largely on professional sports in the first four parts of the book, we include a closing section devoted to amateur sports. This final part provides insights into theories related to the not-for-profit sector of the economy, such as the theory of bureaucracy. Each of the five parts of this text presents significant economic theory and recent evidence and research for that area of economics.

To make the text accessible, we assume that students have had one semester of microeconomics principles. Balancing accessibility against an economist’s desire for theoretical rigor remains a challenge. In order to help the students understand the economics and to make the treatment more entertaining, we have included a generous component of sports history to place the events and economic theory in perspective.

Preface xix

intended audience

Economics of sports classes are taught at a variety of levels, ranging from undergrad- uate courses, with principles of economics as the only prerequisites, to the graduate level. This text is designed to offer a high level of flexibility to the instructor. All the material in the main body of the text should be accessible to students with a single semester of microeconomics principles. In order to enrich courses taught at a higher level, we have included appendices containing intermediate-level material at the end of several chapters. To ensure that all students begin the course with a common back- ground, we provide a substantial review of principles-level material in Chapter 2. This material can either be covered explicitly with lecture support or left to the students to read on their own, as needed. For instructors interested in presenting the results of econometric research, Chapter 2 contains an appendix on the fundamen- tals of regression. In advanced undergraduate- and graduate-level courses, the text can serve as a foundation for common understanding of basic concepts.

organization of the text and coverage optionS

As stated previously, the text is divided into five parts. The first two chapters pro- vide an introduction to sports economics, a review of principles-level tools, and an illustration of how economic principles apply to the sports industry. Chapters 3, 4, and 5 focus on the industrial organization of the sports industry. Here, we discuss the competitive landscape, the implications of monopoly power, profit- maximization, and competitive balance. Chapter 4 focuses specifically on issues of antitrust and regulation and discusses how they have impacted the formation, success, and, sometimes, the failure of leagues. Chapter 5 describes why leagues are concerned about competitive balance, how competitive balance is measured, and how leagues might attempt to alter the balance of competition in a league. Chapters 6 and 7 focus on public finance. In this portion of the text, students learn the benefits and costs of providing public support for stadiums and events, why teams seem to have so much power over municipalities and why municipalities fight so hard to keep the teams they have as well as court new ones. Chapters 8 through 10 focus on labor issues related to sports. Chapter 8 introduces the fundamental theories of labor markets, including human capital theory and tour- nament theory. Chapter 9 covers monopoly unions and monopsony, two labor market imperfections that profoundly impact the functioning of most sports labor markets. Chapter 10 discusses discrimination. Finally, Chapter 11 focuses on the economics of amateur sports, especially major collegiate sports. Because major college sports is really an industry itself, this chapter serves as a capstone to the text, incorporating the theories and concepts from many of the previous chapters.

additional reSourceS

The text is accompanied by an online Instructor’s Manual, updated for the fifth edition by George Diemer of Chestnut Hill College. We are pleased to provide PowerPoint slides, written by Eva Marikova Leeds of Moravian College that

xx Preface

contain all figures and tables in the text as well as lecture notes for classroom presentation. We are also pleased to offer a Test Bank for the fifth edition of the text, written by, David Chaplin of Northwest Nazarene University which contains additional questions and suggested answers for further classroom or test use. The Instructor’s Manual, PowerPoint slides, and Test Bank may be accessed via the Instructor’s Resource Center at www.pearsonhighered.com/irc.

Students and instructors may also access the text’s companion Web site at www.pearsonhighered.com/leeds. Updated for the fifth edition, the Web site fea- tures chapter quizzes, current Web links, and additional sports data.

acknowledgmentS

In a project such as this, the list of people who contributed to its completion extends far beyond those whose names appear on the cover. We owe personal and profes- sional debts of sincere gratitude to a great many people. First, we thank our team at Pearson including Noel Seibert, Emily Brodeur, Maggie Brobeck, and Carolyn Terbush. We also are grateful for the advice, encouragement, and suggestions from the ever-growing community of sports economists who use this book. Their input and support serve as a continuing source of motivation and assistance. We would particularly like to thank all of those who read and reviewed the manuscript as we prepared the fifth edition, including Andrew Zimbalist, Smith College; Bruce K. Johnson, Centre College; Mary N. Gade, Oklahoma State University; Nancy Jianakoplos, Colorado State University; Phil Miller, Minnesota State University– Mankato; Joshua Price, University of Texas–Arlington; and Wayne A. Grove, Le Moyne College. Their suggestions for improvements were excellent, and we tried our best to incorporate them wherever possible. A special thanks to Eva Marikova Leeds for her diligent review of the manuscript during the revision process. Finally, as always, we thank our families: Eva, Daniel, Melanie, Heather, Daniel, Thomas, and Eric, all of whom provided unwavering support.

Michael A. Leeds Peter von Allmen

www.pearsonhighered.com/irc
www.pearsonhighered.com/leeds
The economics of sporTs

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P a r t O n e

Introduction and Review of Economic

Concepts

Chapter 1 Economics and Sports Chapter 2 Review of the Economist’s Arsenal

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3

C h a p t e r 1

Economics and Sports

All I remember about my wedding day in 1967 is that the Cubs dropped a double-header.

—George Will1

1George F. Will, Bunts (New York: Scribner, 1998), p. 22. 2“El Clasico TV ratings break record,” December 13, 2011, at http://www.insidespanishfootball.com/el-clasico-tv-ratings- break-record/, viewed March 6, 2012.

IntroductIon

On December 10, 2011, in a game watched by over 60 percent of Spanish television viewers and millions more around the world, the two most successful teams in the top Spanish soccer league, La Liga, faced off in a game that has come to symbolize much more than a soccer contest.2 Real Madrid, long allied with Spanish conservatism, jumped to an early 1–0 lead, only to lose 3–1 to its archrival, FC Barcelona. “Barça” is so much a symbol of Catalan pride that the team motto is “More than a club.” As always, the win touched off an enormous celebration in the winning city. Just a few months later, more than a million New York Giants fans filled the streets of Manhattan for the ulti- mate celebration—a ticker tape parade—following the Giants Super Bowl victory, while at the same time the city of Boston was awash in the excitement brought on by the annual “Beanpot” hockey tournament between Northeastern, Harvard, Boston College, and Boston University.

Sports occupy a unique position in the human psyche. Athletic contests around the world have long been a way for individuals, institutions, cities, and nations to define themselves. Sports can bring out the best and the worst in people. As early as the 19th century, universities used football to give their students a sense of identity. Cities feel that they have achieved “big-time” status once

http://www.insidespanishfootball.com/el-clasico-tv-ratings-break-record/
http://www.insidespanishfootball.com/el-clasico-tv-ratings-break-record/
4 Part 1 • Introduction and Review of Economic Concepts

they have attracted a major league franchise. At the national level, Japan’s perfor- mance in the 2011 Women’s World Cup provided a much-needed lift to a country devastated by the earthquake and tsunami and shaken by a near nuclear disaster. At the same time, police have had to quell riots on campuses in the wake of heart- breaking losses—or big victories. Reports of domestic violence rise in cities when “their” team is upset in the Super Bowl. In their pursuit of national pride, coun- tries have sometimes sacrificed the physical well-being of their young athletes by giving them performance-enhancing drugs that have had dire side-effects.3

Sports can also serve as tools by which nations conduct foreign policy. They have brought people together, as was the case in 1971 when a team of American table tennis players and their “ping-pong diplomacy” marked the first step in the reopening of relations between the United States and China. They have also kept people apart, as demonstrated by the boycotts that disrupted the 1976, 1980, and 1984 Olympics.

The clamor over sports might lead one to think that the sports industry domi- nates the world economy. In fact, compared to many firms, let alone industries, it is a very small operation. According to Forbes Magazine, the total revenues gener- ated by the four major North American sports leagues (basketball, baseball, football, and hockey) totaled about $21 billion in 2010, which would not rank among the top 100 revenue-generating companies. The sports’ revenues are about one-twentieth of those of Walmart and roughly equal to the $21.6 billion generated by Northwestern Mutual, yet, unlike sports, Walmart does not have its own section in any newspaper, and the local insurance company does not merit a segment on the evening news.4

This book harnesses this enthusiasm for sports and uses it to introduce a variety of economic concepts. These concepts frequently have applications beyond the business of sports. For example, understanding how sports leagues exercise monopoly power provides deeper insight into the policies followed by the Organization of the Petroleum Exporting Countries (OPEC) or Google, and learning about the impact of free agency on team payrolls shows how free markets affect the distribution of incomes in an economy. Studying sports economics thus provides more than an appreciation for the sports industry. It also demonstrates how economic reasoning helps us understand the world around us.

1.1 the organIzatIon of the text

The text is divided into five parts. The remainder of this part provides an extensive review of basic economic theory, particularly supply and demand, the basics of production theory, and models of perfect competition and monopoly.

3See Katie Kindelain, “Kentucky Students Riot after NCAA Championship Win,” abcnews.com, April 3, 2012, at http://abcnews.go.com/blogs/headlines/2012/04/kentucky-students-riot-after-ncaa- championship-win; David Card and Gordon B. Dahl, “Family Violence and Football: The Effect of Unexpected Emotional Cues on Violent Behavior,” Quarterly Journal of Economics, vol. 126, no.1 (February 2011), pp. 103–143; Steven Ungerleider, Faust’s Gold: Inside the East German Doping Machine (New York: Thomas Dunne Books, 2001). 4“Fortune 500,” Fortune, May 12, 2012, at http://money.cnn.com/magazines/fortune/fortune500/ 2011/full_list/index.html, viewed March 8, 2012.

http://abcnews.go.com/blogs/headlines/2012/04/kentucky-students-riot-after-ncaa-championship-win;
http://abcnews.go.com/blogs/headlines/2012/04/kentucky-students-riot-after-ncaa-championship-win;
http://money.cnn.com/magazines/fortune/fortune500/2011/full_list/index.html
http://money.cnn.com/magazines/fortune/fortune500/2011/full_list/index.html
Chapter 1 • Economics and Sports 5

The tools introduced in Chapter 2 are used throughout the text to inform a wide variety of questions in the broader sports industry.

The next three parts of the text are devoted to showing how three particular areas of economics provide insight into how sports function. Part Two presents the industrial organization of sports. Industrial organization is the study of how firms maximize profit. In Chapter 3, we discuss the purpose and structure of a variety of professional leagues. We also review the competitive and monopoly market structures and discuss the implications for profit maximization in each case. In Chapter 4, we extend the discussion of monopoly and analyze the chal- lenges that concentrated markets create for consumers. In Chapter 5, we investi- gate the desirability of competitive balance, how it can be measured, how it has changed over time, and how leagues have dealt with unbalanced competition.

Part Three contains two chapters on the public finance of sports. Public finance asks how and why governments provide goods and services and how they raise the funds to pay for them. In Chapter 6, we discuss the potential benefits of new arenas for both teams and the cities in which they play and describe how the size and shape of facilities have evolved. In Chapter 7, we turn to the cost of these facilities, includ- ing an analysis of why local governments might pay some or all of these costs as a form of investment and, if the investment is made, how to best fund it.

Part Four covers the labor economics of professional sports. Labor economics analyzes how markets determine the level of employment and compensation. In Chapter 8, we use labor markets to explain why professional athletes receive such high salaries. In doing so, we introduce basic labor market concepts, such as human capital, and analyze the potential impact of teams and leagues as pow- erful employers on wages. Chapter 9 explores labor market institutions, such as player associations, which also affect salaries and working conditions of players. In Chapter 10, we discuss the history and implications of discrimination in profes- sional sports. From the informal yet strictly enforced “color lines” that marked the National Football League (NFL) and Major League Baseball (MLB) until 1946 and 1947, respectively, to the limits that such leagues as Nippon Professional Baseball still place on how many foreign players are permitted on team rosters, sports pro- vide many examples of discriminatory behavior.

Finally, in Part Five (Chapter 11), we broaden our study of sports to include amateur athletics at the Olympic and major college levels. We present the history of amateurism and the consequences that misperceptions about this history have had for the National Collegiate Athletic Association (NCAA). This chapter also examines the effects of recent changes in admissions and eligibility standards on schools and athletes.

Special features and additional resources

There are two types of feature boxes in the text. The first highlights specific legal decisions that have had a major impact on the structure of professional sports. Economics does not exist in a vacuum, and these cases are vitally important to understanding how certain groups have used or tried to use economic power to their advantage, sometimes in conflict with laws such as those that apply to dis- crimination, antitrust, and fair labor standards. The second contains biographical

6 Part 1 • Introduction and Review of Economic Concepts

sketches. The world of sports is filled with colorful personalities that add to our enjoyment of the game. Some of these people are well known to even the casual sports fan. Others are less known, but all have played an important role in the evo- lution of the economics of sports. These biographical sketches, the first of which appears in this chapter, highlight both their accomplishments in the context of the chapter and their character as individuals.

As you progress through the course, we encourage you to make full use of the Internet as a powerful and easy-to-use source of further reading. First and foremost, the publisher of this text, Addison Wesley, maintains a Web site specifi- cally designed to support the book. Log on to www.aw-bc.com/leeds_vonallmen and you will find a set of interesting links to other valuable sites as well as infor- mation that we provide directly to assist you. The site is updated regularly so that it contains links to sites and stories that are sure to be of interest.

In addition, virtually every major (and almost every minor) league team and individual sports league or association has its own Web site. These sites are continu- ally updated with information about news (including economic events) from around the league. Finally, many sports magazines maintain Web sites that have current and archived information that can be very useful for term papers, projects, and general information. One caution: Beware of unreliable information that is rampant on non- commercial, individual blogs and private Web sites. The information they convey is often based on opinion rather than on fact and is of little or no value.

Let the games begin!

1.2 BaBe ruth and comparatIve advantage

Economics can often help to resolve what at first glance seems to be puzzling behavior. We begin most chapters by posing a few puzzles that people have faced in the sports world. The material that we present in each chapter then helps us to solve the puzzles that we raise at the outset. This section provides a taste of what is to come. We use the theory of comparative advantage, a concept normally used by specialists in international trade, to explain why the Boston Red Sox stopped using the best left-handed pitcher in baseball in 1918.

opportunity costs

In 1915, a young left-hander for the Boston Red Sox emerged as one of the domi- nant pitchers in the game, helping the Red Sox to World Series championships in 1916 and 1918. In the 1918 World Series, he won two games and set a record for consecutive scoreless innings that stood until 1961. From 1915 through 1918, he won 78 games and lost only 40, and he allowed slightly over 2 runs per game. In 1919, he pitched in only 17 games and won only 16 more games in the rest of his career, yet no fans complained. The reason was that the young pitcher was none other than George Herman “Babe” Ruth, who went on to redefine baseball as a power-hitting rightfielder for the Red Sox and later for the New York Yankees.

Babe Ruth confronted the Red Sox with the classic economic problem of opportunity costs. An opportunity cost is the value of the best forgone alternative.

www.aw-bc.com/leeds_vonallmen
Chapter 1 • Economics and Sports 7

We all face opportunity costs in our everyday lives. Our limited time, income, and energy constantly force us to choose among alternative actions. When we go to the movies on Saturday night, we no longer have the time or the money to go to a concert that evening. When the Red Sox used Babe Ruth as a rightfielder, they gave up the chance to use him as a pitcher. (Because the main contribution of a rightfielder is as a hitter, we will use the term “hitter” rather than rightfielder from now on.) If the goal of a team is to win as many games as possible (an objective we will explore later in this text) then the opportunity cost of using a player at one position is the wins that the team sacrifices by not using him at another position. When the Red Sox used Babe Ruth as an outfielder, they sacrificed wins by not having a great pitcher in their rotation. If they had kept Ruth as a pitcher, they would have sacrificed wins by not having a great hitter in their lineup.

absolute and comparative advantage

It is usually easy to decide where to use a player, as only a few players make good pitchers, and pitchers are typically bad hitters. Babe Ruth, however, was an exception. He was the best pitcher and the best hitter on the team. Being the best at everything meant that Babe Ruth had an absolute advantage at both pitching and hitting. A person or country has an absolute advantage in an activity when it is more efficient at that activity than another person or country. For example, if the United States can make cancer drugs using fewer resources than Japan can, it has an absolute advantage in making cancer drugs. Because Babe Ruth was a better pitcher and hitter than any other player on the Red Sox, he had an absolute advantage over all his teammates in both pitching and hitting.

The Red Sox decided to use Babe Ruth as a hitter because, although he had an absolute advantage as both a hitter and a pitcher, his absolute advantage as a hitter was much larger than his absolute advantage as a pitcher. This meant that Babe Ruth had a comparative advantage as a hitter. A person or country has a comparative advantage when the opportunity cost of an activity is lower than it is for another person or country. Because Babe Ruth was such a good hitter, the opportunity cost of using him as a pitcher (the number of wins the team would sacrifice) was extremely high, much higher than for other players on the team. This meant that, even though Babe Ruth had an absolute advantage over his teammates as a pitcher, he did not have a comparative advantage as a pitcher.5

To see the gains from moving Babe Ruth from the pitcher’s mound to the outfield more clearly, we compare the opportunity cost of using Babe Ruth at each position in 1918. The opportunity cost of using Ruth as an outfielder was the additional runs given up by Red Sox pitchers, which would result in more losses. The opportunity cost of using Ruth as a pitcher was the reduction in runs scored by the Red Sox, which also might have led to more losses. Ruth’s switch

5For a more complete explanation of Babe Ruth’s comparative advantage during his career with the New York Yankees, see Edward Scahill, “Did Babe Ruth Have a Comparative Advantage as a Pitcher?” Journal of Economic Education, vol. 21, no. 4 (Fall 1990), pp. 402–410.

8 Part 1 • Introduction and Review of Economic Concepts

from pitcher to outfielder probably displaced Tilly Walker, arguably the worst of the Red Sox starting outfielders in 1917, and made room for Dutch Leonard, who had the highest earned run average (ERA) among the regular starting pitchers in 1918.6 Ruth’s last year as a full-time pitcher—1917—was an amazing one; he won 24 games, lost 13, and gave up about 2 runs per game. The first year that Ruth played mostly in the outfield was even more amazing. He led the league in slug- ging percentage (the average number of bases advanced per at bat), and his 11 home runs not only led the league but also were almost twice as many as the 6 hit by the entire Red Sox starting outfield in 1917.

Table 1.1 shows that replacing Ruth, who had a 2.01 ERA in 1917, with Leonard, who had a (still low) 2.72 ERA, meant that the Sox gave up 0.71 more runs per 9 innings than they would have if Ruth had had an identical year in 1918. Over the 14 games that Leonard pitched, that meant that the Red Sox’ opportu- nity cost of using Babe Ruth in the field was about 10 runs over the course of the 1918 season.7 Using the formula for runs produced (runs scored + runs batted in − home runs) shows that Ruth produced 29 more runs in 1918 than Walker had produced in 1917. Thus, the Red Sox came out 19 runs ahead from the switch.

At this point, one might ask why the Red Sox did not use Babe Ruth as a pitcher every four or five days and as a hitter every day in between. In baseball, the skills of pitching and hitting are so different that one cannot develop both at the same time. No player has ever managed to play every day and pitch every fourth or fifth day. Acquiring the skills needed to become an elite hitter or pitcher demands a great deal of intensive practice. This pre-commitment generally does not leave enough time or energy to develop alternative skills.

More generally, one of the most important conclusions of the theory of com- parative advantage is that developing particular skills and specializing in activi- ties that use these skills makes individuals, firms, and nations better off. Professors employ research assistants and working parents hire day care providers because

6The earned run average is the average number of runs a pitcher gives up per nine innings, the normal length of a ballgame.

taBle 1.1 The Gain and Loss from Moving Babe Ruth

Player Runs Sacrificed Runs Produced

Babe Ruth 2.01 per game 105 per season Dutch Leonard 2.72 per game — Tilly Walker — 76 per season Net change +9.94 per seasona +29 per season aUses 14 starts for the 1918 season. Source: Baseball Almanac, at http://www.baseball-almanc.com.

7The Boston Red Sox played only 126 games in 1918 because the season was terminated on September 1 due to the United States’ entry into World War I.

http://www.baseball-almanc.com
Chapter 1 • Economics and Sports 9

BioGRaPhicaL SkeTch

Babe Didrikson Zaharias (1911–1956)

I knew exactly what I wanted to be when I grew up. My goal was to be the greatest athlete that ever lived.

—Babe Didrikson Zaharias1

The theory of comparative advantage tells us that athletes are better off when they specialize. A quick look at athletes from the professional ranks to middle schools seems to bear this hy- pothesis out. “Two-way” football players have become a rarity, and athletes who play more than one sport have all but disap- peared. It is thus unlikely that the athletic world will ever see another Babe Didrikson Zaharias. Zaharias dominated the ath- letic world like no athlete before or since, achieving star status in the disparate worlds of basketball, track and field, and golf.

Mildred Ella Didriksen was born in 1911 to impoverished Norwegian immigrants in Port Arthur, Texas. The sixth of seven

children and the youngest girl, Mildred got the nickname “Babe” while a young girl and still the “baby” of the family, though she later attributed the nickname to comparisons with baseball hero Babe Ruth. Her last name was changed to “Didrikson” as a result of a spelling error in her school records.

As a youth, Zaharias was drawn to sports at a time when sexual stereotypes still discouraged women from participating in “manly” sports, but Zaharias’ working-class upbringing freed her from many of the restrictions that would have constrained her development as an athlete. She did not participate in organized sports, however, until she left high school in 1930 to play basketball for the Employers Casualty Insurance Company.

It may seem odd today for an athlete to advance her career by taking a job as a secretary for $75 a month with an insurance company, but at that time, many col- leges did not offer athletic programs for women, and the fledging National Collegiate Athletic Association (NCAA) was openly disdainful of women’s athletics. Employers

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trying to do everything would take them away from the activities that they perform best. It is cheaper (more efficient) for them to pay other people to provide the goods or services than to try to do everything themselves.

At the national level, if the United States has a comparative advantage in the production of cancer drugs, it is better off specializing in cancer drugs and importing TVs even if it has an absolute advantage over Japan in both products. The opportunity cost of sacrificing cancer drugs in order to make TVs ourselves is higher than the cost of sending cancer drugs to Japan in exchange for TVs. Like Babe Ruth, we are better off specializing in what we are relatively best at and leav- ing the rest to others.

10 Part 1 • Introduction and Review of Economic Concepts

Casualty played in the 45-member Women’s National Basketball League, which played under the auspices of the Amateur Athletic Union (AAU). The AAU was then the domi- nant athletic body; it oversaw competitions by a few schools and by companies that sponsored teams.

The Employers Casualty “Golden Cyclones” were one of the best amateur teams in the nation. When the first All-American women’s basketball team was announced in 1929, eight of its members were from Employers Casualty. Zaharias quickly established herself as a star among stars, being named an All-American for three straight years.

As good as she was on the basketball court, Zaharias found her greatest success in track and field. It was here that she recorded the greatest single performance in the history of track and field and perhaps of any athletic competition. The 1932 National Track and Field Competition served as the trials for the 1932 Los Angeles Olympic Games. Zaharias was the sole representative of the Employers Casualty team. In one afternoon, she ensured that Employers Casualty won the team championship by winning the shot put, the baseball throw, the javelin throw, the 80-meter hurdles, and the broad jump. She also tied for first in the high jump and finished fourth in the discus, an event in which she normally did not compete. In all, she won six gold medals and broke four world records in about three hours. Zaharias hardly skipped a beat in the Olympics, setting world records in the javelin throw and the 80-meter hurdles. She also tied for first in the high jump, though her then-unorthodox style (the so-called Western Roll that soon became the dominant style) caused a controversy among some of the judges, who thought it illegal. As a compromise, she was declared the second-place finisher and given the only half-gold-half-silver medal in the history of the modern Olympics.

As the dominant performer and personality of the 1932 “Hollywood Games,” Zaharias quickly became a national celebrity. Her publicity, however, came at a con- siderable cost. The public did not know what to make of a woman who defied sexual stereotypes of the time. Zaharias seemed destined to fade from public view when the AAU stripped her of her amateur status for appearing in an automobile advertise- ment (even though, apparently, she had not given permission for the firm to use her likeness). After a year or so of stunts and exhibition tours, she returned to work for Employers Casualty.

Over the next several years, Zaharias reconstructed her personal and athletic lives. Stung by her treatment in the press, she strove to develop a more feminine image, playing up her role as a wife following her marriage to professional wrestler (and later sports promoter) George Zaharias in 1938, but she was anything but a typical housewife. Having picked up golf as a teenager, Zaharias threw herself into her new, more socially acceptable sport. In 1935, she won the Texas State Women’s Golf Championship and was ready to enter full-time competition when the United States Golf Association banned her from amateur competition because of her appearance in the automobile advertisement. She responded by turning pro, but she quickly realized that professional golf provided neither adequate competition nor adequate remuneration. She succeeded in having her amateur status reinstated in 1943. Though she would have to wait until the end of World War II to enter the next stage of her athletic career, it was worth the wait.

Zaharias burst onto the women’s golf tour in 1945, winning the Texas Women’s Open and the Western Open, and being named “Woman Athlete of the Year” by the Associated Press (an award she had won 13 years earlier for her Olympic exploits). This proved merely a warm-up for 1946, when she won 14 straight tournaments. In 1947,

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Chapter 1 • Economics and Sports 11

Summary

Sports occupy a unique place in the public psyche. Although sports generate less revenue than many other industries, sports results are predicted, reported, and analyzed in newspapers, magazines, books, and TV and radio programs. This text presents economic models from industrial organization, public finance, and labor economics to provide insight into the economics of sports. One of the most important economic models is that of comparative advantage. Despite having an absolute advantage as both a pitcher and an outfielder, Babe Ruth specialized in playing the outfield because that was where he had a comparative advantage. He had a comparative advantage in playing every day as an outfielder because the opportunity cost of his playing outfield—the additional runs that other teams would score against a lesser Red Sox pitcher—was less than the opportunity cost of his playing every four to five days as a pitcher—the lower number of runs the Red Sox would score from playing a lesser outfielder. Following the law of com- parative advantage made Babe Ruth and t