More Competitive Balance

Invariance Principle Owners in baseball have made the claim that free agency has changed the competitive balance in baseball. Their argument is that teams with money can buy up all the talent. So, they say free agency combined with the money has lead to imbalance. Others have argued free agency does not really cause the imbalance. It is just the money that causes the imbalance. The authors develop a different story to have you gain a feel for the free agency story. Let’s turn to that next, shall we? So, the 2014 World Cup (Soccer) will be held in Brazil and the stadium for the final game holds 100,000 (assume for our story). On the next slide we have a graph of the basic supply and demand for the final game. I am going to have you think about the demand curve in segments, so be ready for this idea. On the next slide the curve labeled D is the demand with segments A, B and C.

P Q D S $150 $10 100,000500,000 A B C Segment A of the demand is for those willing and able to pay $150 or more per ticket. Segment B is for those from $10 up to $150 and segment C is for those willing to pay less than $10. (This makes me think about the car brand Cadillac. I am only in the market when the price is really low!)

So, the organizers of the event have to decide how much to charge for tickets to the final game. I want to consider two scenarios or systems. System 1 The organizers of the event should charge the competitive price of $150 and sell 100,000 tickets. This way the organizers of the event will collect $15,000,000 in revenue and people along the demand curve in segment A will get the tickets. System 2 The organizers of the event will charge $10 for a ticket and since folks will want 500,000 tickets a lottery for a chance to buy the ticket will be set up. Do folks along the demand curve in segment C even enter the lottery? No, because they are not willing to pay even $10 for the ticket. (Do you get an envelope and stamp and send in to the Publishers Clearing House Sweepstakes for a chance to win millions? Me neither!) So, will only the folks in demand segment A win the lottery. Not likely. Some folks in segment B will win the lottery. What will the segment B winners do with the tickets that they can buy for $10? Each will sell the ticket and the tickets will ultimately end up in the hands of folks in demand segment A! Why? If you are willing and able to pay $20 for a ticket, for example, and you win the lottery and pay $10 then you can sell the ticket for $150 or more to folks in the demand segment A.

So, with the lottery, the organizers of the event sell 100,000 tickets for $10 and get revenue of $1,000,000. Lottery winners in segment B buy tickets and turn around and sell them for $150, or more. The tickets end up in the hands of those in segment A, but some people in segment B collect money that cold have gone to the organizers if $150 had been charged. Plus the lottery winners in segment A only pay $10 to the game. They have high consumer surplus. What we see here is that in either system the tickets (a resource) end up in the same hands. Invariably, tickets end up in the hands of segment A demanders. But, the money goes to the organizers in system 1, but is way more spread out in system 2. Invariance principle – under any system of property rights to resources, the resources end up in the same place regardless of the system. The distribution of income is the only thing that differs with the type of system used.

Coase Theorem – a special case of the invariance principle In the history of sports we have had two legal rules – what might called property right systems – concerning players. Under the “reserve clause” system a player is really owned by the team that drafts him and can only sign with that team until team gives up the right (through trade). Under free agency the player, at the end of a given contract, can sign with any team. Today we have free agency in pro sports. Owners in the past have claimed that free agency would lead to competitive imbalance because rich teams could get more free agents. The Coase Theorem indicates the rich team will get who they want under either system, free agency or reserve clause structures. Say player A is more highly valued by team X than team Y. In free agency X bids more to get player A. In the reserve clause system team X can give up more in trade than Y (because X values player more) So, the Coase Theorem says the initial allocation of property rights does not matter. This means the player will end up with the team that values him most no matter what the system. The system chosen does matter for how much players and owners get in terms of money. Players tend to make more money under free agency than they would under the reserve clause. It is just the reverse from the perspective of the owners.

Attempts to alter competitive balance Remember we have said parity in a league is important for league financial success. As leagues become unbalanced because big city teams get more revenue and thus buy better talent, leagues develop a process to restore competitive balance. These have included revenue sharing, salary caps, luxury taxes and the draft. Conditions for revenue sharing to contribute to competitive balance -If firms are profit maximizers, teams that receive revenue must benefit from improving their performance. If there is no net benefit they may just keep the money. -Player mobility has to be real in terms of free agency or buying/selling/trading, and -Net gainers of revenue know how to go about making the team better!!!! (Do teams know about Moneyball?) Salary cap A salary cap is a limit to what a team can spend on player salary in a year. Teams that violate the cap are subject to penalty. Some have claimed that this has only lead to owners keeping more of revenue and players get less. The theory of the salary cap is you make the cap low enough that no one team can buy all the talent. Luxury tax - A luxury tax is a soft cap. In other words, if a team goes over a set amount of payroll they will have to pay a tax of a certain % for every dollar the payroll is over the limit. Some have claimed neither the cap nor tax has really worked because leagues are not strict enough in enforcement of the limits.

The draft Most pro leagues have a draft of new players. Usually the worst team in a year gets to draft a new player first. Then the order of finish is followed up the champion drafts last. The NFL has an element of introducing parity in how it schedules games. High winning percentage teams in one year play other high winning percentage teams in the following year. Attempts to alter competitive balance may fail because buying talent may not lead to wins because -Injuries to stars may occur -Bad attitudes -Lack of chemistry -Draft choices are a bust.