Economics and the mid-life crisis have much in common: Both dwell on foregone opportunities

C'est la vie; c'est la guerre; c'est la pomme de terre . . . . . . . . . . . . . email: jpalmer at uwo dot ca

. . . . . . . . . . .Richard Posner should be awarded the next Nobel Prize in Economics . . . . . . . . . . . .

Thursday, January 06, 2005

How Can the Yankees Afford Those High Salaries?

Even asking this question in this manner means the student is likely (though not certain -- see below) to fail my course in The Economics of Sports. The reason is that when most of us think of how can we afford to buy a big-screen tv, we think of how much money do we have and how much can we borrow?

But for a business, in addition to those questions, it is important to ask, how much more will it cost me to sign Player X and how much more will signing that player yield in additional revenues. (and then do a comparison with Players Y and Z). The decision on whether to sign a big-name big-salary player is usually an incremental, forward-looking decision about expected additional costs and additional revenues and has little or nothing to do with the net worth of the team or its owner; and from a profit- or wealth-maximizing perspective, it has nothing to do with how much the team is already worth or is already earning without that player. I.e., it has nothing to do with what the team can "afford".

The team could be earning ten quadzillion dollars a year, but if signing that player will add to the team's profits, then (from a profit and wealth-maximizing perspective) the team should sign that player. And if the team is losing ten quadzillion dollars a year [please let me know who lent them so much money so I can borrow some, too!], they can reduce their losses if signing Player X will add more to their net profits (or subtract the most from their net losses) than signing Player Y.

According to this article in the NYTimes, the Yankees are losing money by signing big name players. Overall, even if you believe their numbers, that might not be a bad strategy if it means their ancillary operations (e.g. YES cable network) make even bigger gains. Another possibility might be that it is a good consumption purchase by a team owner who is willing to sacrifice profits in order to purchase the utility of winning games -- an owner who might rather sniff the jocks of winners than losers.

"It's an effort to keep the Yankees, always, as by far the premier brand," Ozanian said. "But a lot of what Steinbrenner does is not to maximize profit, it's to win."
In other words, it might be a mistake to push our profit-maximization models too hard when analyzing the economics of professional sports when owners are spending money on consumption as well as on investment.

And if the student says "afford" refers to the consumption aspect of team ownership, s/he probably would not fail, especially if the answer included references to the capital market.
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