BMAN31391 ECONOMICS OF SPORTEXAMINATION 2011-12 MARKING SCHEME

1. Using the information in the box below about the costs and revenues of hosting a major sports event:

(a) Construct an economic impact assessment calculated on the basis of money that flows into the country from outside. (10 marks)

(b) Construct a cost-benefit analysis incorporating the concepts of consumer surplus and opportunity cost. (30 marks)

(c) Explain and justify which method you would use to evaluate the economic benefit of the 2012 London Olympics. (10 marks)

The total cost of building the stadium and athletes’ accommodation is €80m. This is made up of:

Cost of labour €35m Cost of capital equipment, etc. €25m Cost of raw materials, etc. €20m

All raw materials are imported. Due to a skill shortage construction workers are pulled away from other projects. Their lost output on these other projects amounts to €25m.

The total cost of organizing the event is €38 million and is only a labour cost. However, there is again a skill shortage of organization workers and their lost output on other projects amounts to €10m

The organizing committee benefits from the following revenues:

Foreign ticket sales €10m Domestic ticket sales €8m TV rights and sponsorship €36m

(sold to a foreign company)

Revenue from hotels and catering for visitors: €32m

Due to a shortage of hotel rooms and congestion problems, many visitors that would have visited the host city cancel their plans. This lost revenue amounts to €15m

Assume the following: An income multiplier of 1.2. A tax rate of 30 % of extra income Consumer surplus is 50% of expenditure.

All organization profits stay in the host country

Candidates may include an intro discussing the difference in approach between an EIA and a CBA.

1. (a) Counting only the additional funds flowing into the country

- total ticket sales to foreigners €10 million - foreign tv-rights and sponsoring €36 million - lodging and catering, visitors: €32 million

Total foreign spending €78 million

1. (b) We apply two fundamental principles of cost-benefit analysis; the consumer surplus and the opportunity cost.

Returning to the numerical example, the direct financial benefits of the sports event are

Total ticket sales of €18million, Foreign television-rights and sponsorship of €36m Visitors' lodging and catering expenditures of €32m.

The indirect financial benefits of €10m are based on the multiplier effects, created by spending the money on the sports event.

The indirect financial benefits derive from the multplier effects of the income generated by the event. To calculate the multiplier effect, first the student needs to calculate the direct income creation (value added):

In the construction industry, the government has built and financed new sports accommodations for a total value of €80 million, so that income is created and additional workers are employed. However, not all income can be counted as additional income for the organizing country, because some income flows to foreign countries by importing raw materials for €20m and the crowding effects of skills shortage of €.25m This means that the net value added of the construction industry is not €80 million, but only €35 million (€80 − €20 − €25). The organization of the sports event costs €38m and the total revenue is €54m, so that the organizers' profit is €16m. Not all of this profit is additional income however, because of the crowding out of organization workers of €10m. This reduces additional income to €6m.

The lodging and catering of foreign visitors during the event creates €32m extra value added in hotels and restaurants. But because of the €15m displacement of regular tourists during the event, the net value added is only €17m.

Because locals spend €8m on tickets, they do not spend that money on the goods and services that they would have bought if the sports event was not organized. So, this value added and income is lost for other industries in the local economy.

Adding up, direct income creation of the event is €50m. Applying the multiplier of 1.2, the indirect income creation is 10 million (0.2 × 50), so that a total income of 60 million is created.

Direct income creation (value added): €50m - construction industry €35m - organization sector €6m - lodging and catering €17m - loss of other sectors due to ticket sales to locals − €8m Indirect income creation: €10m (multiplier = 1.2)

Assuming that the consumer surplus is 50 % of the sports expenditures of locals (ticket sales), the consumer surplus is €4m. This must be added.

Given the financial cost of 118 million, (80m infrastructure cost + 38m org cost) what is the opportunity cost in the numerical example?

Infrastructure (80m):

leakage → imports of intermediate goods = 20 mcrowding out → construction workers that are in short supply = 25 m Organization (38m)

Crowding out of org. workers equals €10m

Part of the opportunity cost is also the 8 million that locals have not spent on other goods and services because they spent it on tickets. Assuming that the consumer surplus of these other goods and services was 4 million (50% of expenditure), 12 million has to be added to the opportunity cost.

Last but not least, the foreign visitors, attracted by the sports event, can also keep regular tourists out, because of limited hotel capacity. Also this 15 million is part of the opportunity cost. Adding up, the total opportunity cost is 82 million, which is lower than the financial cost of 100 million.

Cost-benefit analysis

Direct financial benefits: 18 + 36 + 32 86 million Indirect financial benefits (multiplier) 10 million Consumer surplus of locals: 4 million

Total benefits: 100 million Total opportunity cost: 20 + 25 + 10 + 12 + 15 82 million Net benefit: (100-82) 18 million ____________________________________________________________________

Adding up, the total benefits are 100 million, the total opportunity cost is 92 million, so that the net benefit for the country is positive at 8 million.

Assessment Criteria MARKS

A (10) B (30) C (10)Completely inappropriate answer 0 0 0Little understanding of the specific demands of the questionVery little recognition of relevant economic theory.Relevant terms not defined.Little attempt at calculating EIA or CBASignificant errors.

1-3 1-10 1-3

Some understanding of the specific demands of the question.Some recognition of relevant economic theory.Some relevant terms defined.Attempt at calculating EIA or CBASome errors.

4-6 12-18 4-6

Understanding of the specific demands of the question.Relevant economic theory explained and developed.Relevant economic terms defined.Attempt at calculating EIA or CBAFew errors.

7-8 19-25 7-8

Clear understanding of the specific demands of the question.Relevant economic theory clearly explained and developed.Relevant economic terms clearly defined.No major errors.Correct calculation of EIA or CBAWhere appropriate, examples used.

9-10 25-30 9-10

2. Would it be accurate to suggest that many of the features observed in sports labour markets are due to the characteristics of a bilateral monopoly?

(50 marks)

Candidates may include an intro discussing some of the features commonly observed in sports labour markets, i.e. “superstar” salaries, players not being paid their MRP, agents, unions, bargaining, etc.

The core of the answer should concentrate on monosony and monopoly in the labour market.

Throughout the question, please credit any valid alternative point

The Sports League Monoposonist

The first step is to examine how a monopsony sports league sets the profit-maximizing price and quantity, WITHOUT a monopoly controlling the other side of the market. This diagram displays the market for labour services in a sport when controlled on the buying side by the league. The vertical axis measures the factor price (wage rate) and the horizontal axis measures the quantity of labour services (labour quality).

The key for any monopsony buyer is that the supply curve it faces for hiring labour is THE market supply curve for the factor. This is the positively-sloped factor supply curve, labelled S in this diagram - if the league wants to add quality it must increase wages. Accompanying the factor supply curve is a positively-sloped marginal factor cost curve, labelled MFC. It lies above the factor supply curve because it shows the cost of hiring an extra unit of quality. Remember if the league wants to add more quality it must increase wages. If it wants hire another quality player it must offer a higher wage. But a higher wage will also be offered to existing players.

The third curve, labelled MRP, is the marginal revenue product curve for the league. This curve is the additional revenue that the league receives as a result of hiring each additional unit of quality. It is based on the marginal physical product of the players and the price of the product (tickets, pay-per-view, etc) - MPP × P = MRP. The MRP curve is, in effect, the demand for labour curve because it shows the quantity of labour demanded at each wage rate.

If we assume profit-maximization, the league hires labour services up to the point in which marginal factor cost is equal to marginal revenue product. This profit-maximizing quantity of labour is L1 and the wage is W1.

0

Wage

SL

MRP (DL)

W1

L1

Labour quality

Figure 2 – A Sports League Monoposonist

MFC

The Player’s Union Monopolist

The next step is to examine how a monopoly like a Player’s Union sets the profit-maximizing price and quantity, WITHOUT a monopsony controlling the other side of the market. This exhibit displays the market for labour services in when controlled on the selling side by the Player’s Union.

Player’s Unions are common is professional team sports

PFA (English football) > abolition of max wage (1961) > amendment of retain and transfer system (1963).

Major League Baseball Players Association > 3 major strikeso 1972 over pension payments - 86 games missedo 1981 over free agency -713 games missedo 1994 over free agency - 931 games overall, including the entire 1994

postseason and World Series.

National Football League Players Association (NFL) > 1982 strike for a month over revenue sharing > unsuccessful strike over same issue in 1987 led to decertification.

We also have AGENTS and SPORTS AGENCIES who could be said to act in the same way as a sole seller of labour services.

0

Wage

MC

DL/MRP

W2

L2

Labour quality

Figure 3 – The Player’s Union Monopolist

MR

The key for any monopoly seller like the Player’s Union, is that the demand curve it faces for selling labour is THE market demand curve for the factor. This is the negatively-sloped factor demand curve, labelled D in this diagram. Accompanying the factor demand curve is a negatively-sloped marginal revenue curve, labelled MR. This represents the extra revenue for the union of one more of it’s members being employed. It lies below the factor demand curve.

This is because the union must lower the wage it is prepared to accept if it wants to increase the number of its members in employment. If it is lowering the wage for this extra member them it must accept lower wages for all existing members. So the union gains some revenue from having an extra member employed, but loses some revenue from having to lower the wages of all the other players it represents.

The third curve, labelled MC, is the union's marginal cost curve. This curve is the additional cost the union incurs for each additional player who becomes a member. More members require more representation.

If it is a profit-maximizing entity, the Union provides labour services up to the point in which marginal cost is equal to marginal revenue. This profit-maximizing quantity of labour is L2 and the wage is W2.

A bilateral monopoly emerges by combining the league’s monopsony with the player’s union monopoly. Because the profit-maximizing price charged by the players Union monopoly (W2) is higher than the profit-maximizing price paid by the league monopsony (W1), both sides cannot maximize profit. The price ultimately achieved in

0

Wage

S/MC

DL/MRP

W2

L2

Labour quality

Figure 4 – Bilateral Monopoly

MR

W1

L1

MFC

Negotiating range

Monopoly wage

Monopsony wage

this market depends on the relatively negotiating power of each side. The wage is indeterminate.

Assessment Criteria MARKS

(50)Completely inappropriate answer 0Little understanding of the specific demands of the questionVery little recognition of relevant economic theory.Relevant terms not defined.No attempt at diagrammatic analysisSignificant errors.

1-15

Some understanding of the specific demands of the question.Some recognition of relevant economic theory.Some relevant terms defined.Reasonable attempt at diagrammatic analysisSome errors. Some real world examples used

16-30

Understanding of the specific demands of the question.Relevant economic theory explained and developed.Relevant economic terms defined.Very good diagrammatic analysisFew errors.Good examples used.

31-40

Clear understanding of the specific demands of the question.Relevant economic theory clearly explained and developed.Relevant economic terms clearly defined.No major errors.Excellent, well explained diagrammatic analysisMany good examples used.

40-50

3. (a) Sports broadcasting markets are regulated in most countries. Outline two important restrictions on sports broadcasting and use economic theory to explain why they exist. (25 marks)

(b) Consider the normal form game in the table below. This game involves two TV channels, A and B, both of which can adopt two alternative strategies; aggressive market policy or moderate market policy. The first alternative means bidding aggressively in auctions and also broadcasting many sports programmes. The second alternative is characterised by more moderate behaviour in auctions and also fewer programmes being broadcast.

Channel B = Aggressive Market Policy

Channel B = Moderate Market Policy

Channel A = Aggressive market Policy

40, 40 100, 20

Channel A = Moderate market policy

20, 100 70, 70

Note: The payoffs for Channel A are the first number in each cell. The payoffs for Channel are the second number in each cell.

(i) What is the solution to this game? Are there any dominant strategies? (10 marks)

(ii) How does this game illustrate the over provision of televised sport on TV and the “winner’s curse” as it applies to broadcasting rights. (15 marks)

For (a) Candidates may include:

Intro discussing sports broadcast markets (growth, technology, etc.) Regulations could include:

o The “listing” of important events.o Vertical merger judgements.o Competition issues.o Collective selling of rights in soccer/ revenue sharingo 1961 Sports broadcasting Act (US)o “blackouts” (US)

Economic theory could include:o Public goods/merit goods theory.o Theory of the firm (monopoly etc.)o quirk & Fort model to examine revenue sharing.

For b(i) Candidates may include:

Definition of a game. Discussion of why game theory is used in economics. Definition of a dominant strategy. The solution to the game is the “top-left” cell. Both channels have a dominant

strategy of following an aggressive market policy.

For b(ii) Candidates may include:

Explanation of sub-optimal equilibrium. Profits are higher in “bottom-right” solution.

Application/discussion to actual sports broadcasting markets (over-supply, saturation, zero-sum game).

Definition of the winners curse. Application to unprofitable over-bidding for rights/bankruptcies.

Assessment Criteria MARKS

A (25) B(i) (10) B(ii)(15)Completely inappropriate answer 0 0 0Little understanding of the specific demands of the questionVery little recognition of relevant economic theory.Relevant terms not defined.Significant errors.

1-3 1-10 1-3

Throughout the question, please credit any valid alternative point

Some understanding of the specific demands of the question.Some recognition of relevant economic theory.Some relevant terms defined.Some errors.

4-6 12-18 4-6

Understanding of the specific demands of the question.Relevant economic theory explained and developed.Relevant economic terms defined.Few errors.

7-8 19-25 7-8

Clear understanding of the specific demands of the question.Relevant economic theory clearly explained and developed.Relevant economic terms clearly defined.No major errors.Where appropriate, examples used.

9-10 25-30 9-10

4. “The implication of Rottenberg’s (1956) Invariance Thesis for professional team sports is that the distribution of talent would be identical under either the reserve clause or free agency”. Discuss. (50 marks)

Candidates may include:

Description of the Coase theorem/invariance thesis with example Application of Coase theorem/invariance thesis to sport with example(s) Discussion of whether observed outcomes in sport support the Coase

theorem/invariance thesis. Diagram to illustrate the invariance thesis in sport (the Fort/Quirk diagram

was used in the lecture). Discussion of whether observed outcomes correspond to the predictions of the

CT, possibly with data or very good real-world examples.

Throughout the question, please credit any alternative point

Assessment Criteria MARKS

(50)Completely inappropriate answer 0Little understanding of the specific demands of the questionVery little recognition of relevant economic theory.Relevant terms not defined.No attempt at diagrammatic analysisSignificant errors.

1-15

Some understanding of the specific demands of the question.Some recognition of relevant economic theory.Some relevant terms defined.Reasonable attempt at diagrammatic analysisSome errors. Some real world examples used

16-30

Understanding of the specific demands of the question.Relevant economic theory explained and developed.Relevant economic terms defined.Very good diagrammatic analysisFew errors.Good examples used.

31-40

Clear understanding of the specific demands of the question.Relevant economic theory clearly explained and developed.Relevant economic terms clearly defined.No major errors.Excellent, well explained diagrammatic analysisMany good examples used.

40-50

5. Administrators of professional sports leagues throughout the world have introduced regulations designed to improve competitive balance in their leagues. Using examples of two different regulations,

(a) Outline the economic reasons for introducing them (20 marks)(b) Use economic theory to predict whether they are likely to be successful.

(20 marks)(c) Show how you would empirically test the theory from (b). (10 marks)

For (a) Candidates may include:

Too many regulations to list, but may include:

o Reserve clause/retain & transfer systemo Draft systemo Roster/squad limitso Restrictions on franchise location (US)o Revenues sharingo Salary capo Financial Fair play.o Luxury tax (US)o

Discussion of economic reasons will centre around comp. balance/uncertainty of outcome, but may include issues such as financial viability, profit maximisation or other objectives

For (b) Candidates may include:

Application of invariance thesis to reserve clause/retain & transfer system. Application of Fort & Quirk model to salary cap/luxury tax/revenue sharing

For (c) Candidates may include:

Discussion of the testing of economic theory using models. Discussion of data to be used for testing.

6. Explain the economic incentives facing athletes in individual sports such as tennis, golf and motor racing, and discuss the problems encountered by tournament organisers in designing prize structures. (50 marks)

Candidates may include:

In the explain section:

Explanation of the forms of discussion in non-team sports (match play seeding) and the effect this can have on incentives.

The promoter’s problem who has to decide on: The promoter has to decide on:

o the total amount to spend on players either as appearance money or as prizes

o How much to offer as appearance money and to which players.o The gradient in prize money from 1st to 2nd to 3rd….

Incentive effects may operate in 2 ways:

May induce higher quality performers to enter the comp. May induce greater effort level from each entrant.

(Figure 1) Suppose we have 3 athletes A1, A2 and A3, of varying abilities with A1 representing the highest and A3 the lowest, and three athletics races offering varying MINIMUM prizes D1, D2 and D3 → D1 highest. Willingness to enter race is function of the minimum expected prize. The supply curve will have 2 components: (1) the response of the athletes in deciding whether to compete; (2) response to higher prizes in terms of effort expended

A3

Expected prize

runner performance (speed)

D1

D2

D3

A1

A2

A3

Figure 1 – response of runners with different abilities to differential prize levels

Explanation of tournament theory. The following diagrams showing the marginal cost of effort related to differential rewards were presented to students. Thorough explanation should accompany these.

In the discuss section:

Application to actual tournaments. discussion of tournaments where rewards are not skewed to top places (motor

racing). Critical analysis of tournament theory.

Learning Outcomes/ Question matrix

Q1 Q2 Q3 Q4 Q5 Q6i. Critically evaluate the theoretical literature relating to economics of sport;

X X X X X X

Demonstrate an awareness of /the distinctive characteristics of labour and product markets in professional team sports, and their implications for economic analysis;

X X X X

Demonstrate an appreciation of the role of the empirical work in testing the various theories;

X X X X

Understand the implications of theoretical and empirical work in the economics of sport for policy issues including competitive structure in sport leagues, free agency and player mobility, and the financing of professional sport.

X X X