Sports Economics
May 4500
Chapter 4 - Answers
Review Questions
1.
What is the profit maximization hypothesis? If teams earn very low profits or lose money, does
this mean the owner does not maximize profit? Can owners who make systematic mistakes
survive in a league of profit-maximizing owners? How?
Answer: The profit maximization hypothesis is that owners make all decisions to maximize profits.
If teams earn low profits, the owner may be attempting to maximize profits and not succeeding,
or he may be maximizing wins. Owners who make systematic mistakes cannot survive in a league
of profit-maximizing owners. Eventually such an owner will be bought out by a person who can
make more profitable use of the team.
8.
What is the main determinant of where teams end up in the standings; that is, what determines
whether they win more or not? For our purposes, what is the definition of a star player? Explain
how star players contribute to a roster that has no stars.
Answer: The main determinant of where teams end up is their players; specifically, how many
stars or players of high quality the team is able to afford. A star player is a player who has a
significant impact on a team’s ability to win (greater than an average player’s ability to increase
any given team’s winning percentage). Star players that join a roster with no stars have the
greatest ability to impact that team. Additional stars have less impact (lower MP), given
diminishing marginal returns to labor.
12.
Why is there conflict from the owner’s perspective between winning and costs? What is talent
dumping? Why does it occur?
Answer: There is conflict between winning and costs because stars, who contribute the most to
winning, are the most costly labor to hire. Because owners are profit maximizers, they must
equate the marginal revenue of a player who will help the team win with the marginal cost of that
player. To win most often, a team will have to hire more stars, and the cost of those stars may
not be offset by the revenue they bring in, therefore they may not maximize profit. Talent
dumping is the term used when an owner trades are star player. It occurs because stars cost
much more than average players and such stars may not bring in the revenue to support their
employment with that team.
13.
How do profits constrain winning? How can profit variation harm competitive balance?
Answer: Profits constrain winning because the cost of hiring stars increases at an increasing rate,
while the productivity of stars and marginal revenue of winning percentage both fall. To win may
cost more than the revenue generated. This harms competitive balance because smaller market
teams cannot afford to hire stars; i.e., they cannot afford to buy enough talent to win.
Thought Problems
6.
A team owner tries to decide quality level. By spending another $12 million, the owner expects
that the team will finish one place higher. Does this mean that the owner can raise the team’s
place in the standings by one place for each $12 million spent? Why or why not?
Answer: Eventually, the owner is in the long run range of quality choice where costs are rising, so
each subsequent step up in the standings will cost increasingly more. A complete answer might
demonstrate this using Table 4-7 and Figure 4-3. In the long-run, limits to management eventually
lead to increasing costs of quality. In Figure 4-3, this occurs beyond a winning percent of 0.598.
10.
When a player says that an owner doesn’t want to win, what is really being said?
Answer: From the perspective of long run profit maximizing owners, such a statement can be read
to mean that the long run profit maximizing level of talent that would be chosen is below 0.500.
Or, if the team typically contends for the championship, then the long run profit maximizing level
isn't enough to produce a consistent champion.
11.
Fans always crave a better team. Often they grow weary of ownership that won’t give them one.
If the team changes owners, when will fan expectations of improvement be met? Relate your
answer to the Disney example in the Learning Highlight: When Can a New Owner Change a Team’s
Fortune?
Answer: Fans' expectations can be met if 1) the previous owner had misjudged the revenue
structure of their market and the new owner knows better or 2) some sort of funding constraint
stopped the previous owner from obtaining the level of talent known to be most valued by fans.
In the Disney example, it appears that neither of these was true. Disney has managed a bit better
talent on the field, but no results in terms of profits since both their hockey and baseball teams
are on the market.
15.
How would you determine whether a given pro sports team owner tries to maximize profits? Why
would the team’s annual net operating revenue statement not be very helpful in your analysis?
Answer: If a team is like a hobby, then one would expect the owner to equate the extra personal
satisfaction to the extra cost of winning. It is difficult to know what this does to the demand for
talent, the primary determinant of costs. Suppose the owner wants to maximize winning, but
refuses to lose money doing it (a break-even constraint). In this case, we know that all owners will
increase the demand for talent and payments to talent will rise. One way to judge other
objectives is in the payment to talent; the owner might consistently compensate talent at greater
than the market rate. Sometimes, given the idea that we can estimate revenues, one might find
that the talent level in a given location is larger than that revenue market can support. This also
would indicate that the owner is not maximizing profits.