Managerial Economics: Developing Practical Tools and Concepts

The purpose of this paper is to reflect on experiences and knowledge gained in the module of Managerial Economics. The study of Managerial Economics helps develop practical tools and concepts for individuals and businesses. It exceptionally combines the discipline to other managerial

functions, including accounting, finance, human resource management, and marketing. Managerial Economics teaches an individual how to make better business decisions. Economics and perfect competition play very important roles in the field of sports. Sports are organized among individuals and among teams, both professional and amateur. Most of the interesting questions on the economics of sports relate to professional team sports, which are the focus here. Examine how player achievement, pay structure, and salary limits are all components dealing with the economics of sports. “Economics means different things to different people. To some if means thriftiness, budgeting for household purchase, or saving for an automobile. To others is means analyzing a multimillion dollar income statement.” (Mastrianna & Hailstones, 2001, p. 1).

Up until now, many athletes were limited from switching clubs in a league. Club owners say that reservation of players or the introduction of transfer fees was needed to preserve the financial security of small clubs and to protect competition between the leagues. The appeal of professional team sports is the extraordinary playing ability of the athletes. This is demonstrated repeatedly on television and commented on widely. Such achievements are value maximizing for the leagues since they promote interest in the sport. For instance, baseball has been given a renewed spirit due to the spectacular race a few years back to break the home run record by Mark McGuire and Sammy Sosa. While there are many ways of measuring player achievement, none excites more discussion than “hot hands”. The less athletically inclined would like to know how the players achieve those long runs of seemingly supernatural skill. But, there is nothing to the “hot hands” phenomena, and the hot streaks are no different than a freak occurrence of same-side landings during successive coin flips. The best basketball players in the world still only manage to make an average of half of their free-throw shots. Over an entire season, those players would be expected to have at least one run of seven made shots in a row, and in their entire career, a sequence of ten in a row. Of course, players that have higher shooting averages can be expected to have longer streaks of luck.

The salary for a professional athlete’s skills or abilities is not a set amount. For instance, if a team has a player who is twice as good as one of his teammates that is measured by the same performance measurements, he or she does not receive twice the salary amount. Oddly, comparatively small differences in their performances end up creating large differences in their salaries. Salaries in professional team sports are based on the positions they play. The owners of teams, or event sponsors, want all their players to build up their skills to their utmost potential and for them to give it their all every time. Of course, this is all done with profit as motivation. Games where everyone is playing at their max and where they are concentrating on winning are very profitable for the owners. Sports where there is no team involved, like tennis and golf, are strictly dependent on rankings. The payments or prizes are set up beforehand and the next higher payment is gained by moving up one spot in the tournament. On team sports, everyone competes for the higher-paying starting positions and the less-paying backup positions. This causes the starting players to constantly feel inclined to perform at their maximum potential lest they lose their spot to their backup.

Now with the advent of veteran free agency status in team sports, owners needed a way to keep salaries from reaching ruinously exorbitant sums. One way, which was contributed by basketball, is the team salary cap. The salary cap sets a maximum salary as a percent of gross revenue. Football uses one, and baseball wants one, but has been prevented from implementation by the players’ union. Do they work? Imagine that a salary cap is set that locks in player salaries to a certain percentage of league revenues. The marginal cost of athletes falls under the cap from its level under free agency. If it is rigorously enforced, all teams should have the same salary costs, and if there are no information irregularities about performance and the quality of the coaching is the same, all teams will have 0.500 records.

The distribution of win stats caused by an enforced salary cap is stable, but it is not profit maximizing, and it does not maximize league revenue. A large city team profits more by hiring better players and a small team can earn more by lowering its level of athlete’s talent. In basketball, the salary cap is occasionally avoided by using the so-called Larry Bird exemption. This states that a team may re-sign a veteran free agent even at a cost above the salary cap, and it will not count towards the cap. The end result of this is that now most team’s player payrolls greatly exceed the salary cap, and this changes the concept of a salary limit into a soft constraint. Obviously, the Larry Bird exemption was a very large point of dispute between the team members and the owners.

The implementation of salary caps also led to other creative ways around them such as large signing bonuses relative to annual salary, back-end loaded long-term player salary contracts, deferred player compensation, and the redirection of money from team operations to other, non team entities. With enough weakening in the constraint of the salary cap, as with a player reservation system with player transfers for cash, it can lead to the same distribution of talent as there is in sports with unrestricted free agency.

A very important part of playing quality is the ability of the teams on the field. Fans want their favorite team to win, but with some competition. If the top team always beat the next ranked team, and so on, fans would soon lose interest and the games would have little to no market value. There has to be some kind of competition between the teams in order to hold the interest of viewers. The way to do this is to keep the playing strengths of the teams at levels comparable to the other teams. Keeping the playing strengths equal between the teams is wealth maximizing. Attendance at games and viewer ship on television is higher the closer the standings of the clubs are over a season. Competitive balance depends mainly on the financial strengths of the clubs. As Sheehan states, “Gate revenues on average are the largest source of league income, followed closely by media revenues” (p. 64). The main cost is player payroll.

Attendance is determined mainly by market size and the club’s record. Since teams are located in cities of markedly different size, the prospect of fielding a competitive team depends in part on where the club is located, but also on how revenues are divided up among the clubs. For instance, in basketball and hockey, the home team receives all of the money from ticket sales, and in baseball, the team receives 85 percent of the ticket sales. In football, their percentage is dropped to 60 percent. All national broadcast revenues are divided evenly among the teams in all of the sports. The amounts for dividing up the gate receipts are linked to the difference in team financial status across different leagues. With clubs spread around in unequal size markets, the ban on unilateral relocation of clubs to the more lucrative markets and the more unequal the division of revenue among clubs, the less will be the competitive balance within that league.

In closing, the module of Managerial Economics can bring a better understanding of how economics plays a vital role in the disciplines of accounting, finance, human resource management, and marketing. Managerial Economics not only is important in the business world, but also in the very serious business side of professional sports. As illustrated, economics and perfect competition are essential in the way the economy functions, evolves, and operates.

Mastrianna, F. & Hailstones, T.J. (2001). Basic economics (13th ed.). Canada:
South-Western College Publishing
Sheehan, Richard G. (1996). Keeping score: The economics of big time sports.
South Bend, IN: Diamond Communications, Inc.

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