Appendix 2

(from VanFossen, P. J. (1995). Underpaid millionaires? The Senior Economist,

Major League Baseball: A Monopsony?
During the 1994 baseball season, the average MLB player's salary was nearly $1 million dollars and, apparently (as evidenced by the 1994 player's strike) the players did not deem even this figure high enough. Many baseball fans cried "foul" when player's claimed they were not getting their fair share of the MLB owners' profits. What about this claim? Are owners paying players what they are worth? Are the owners overpaying players and thus acting outside their own self-interest? In order to solve this economic mystery, we must first examine the characteristics of a special market situation called a monopsony.

A monopsony is a market in which only one buyer of some resource or input exists. (Contrast this characteristic of a monopsony with a monopoly: in the extreme case, a monopoly has only one seller of a good or service.) Because a monopsony market is not a truly competitive one, the price that the one buyer pays for any resource or input may often be less than in a competitive one.

This "underpayment" is measured by economists as monopsonistic exploitation. This concept refers to the percentage of the underpayment for an input found in a monopsony relative to the price this input (in this case, MLB talent) might bring in a competitive market

Firms that wield monopsonistic exploitation over a particular input may also hold significant control over the market for the product produced using that input, particularly when this input has a very specialized use. In the case of labor input, this phenomenon might be represented by some very special skill or talent (e.g., the US Navy hires nuclear engineers to run its nuclear subs; few, if any, other firms need this specialized skill).

Several related firms may also enter into an agreement regarding hiring decisions that allow these firms to develop a type of monopsonistic power over a particular market. If all firms in a given industry agree not to pay employees above a certain wage, they are no longer in direct competition for labor - a worker can either sell his input at the agreed upon rate or move to another industry - and act, in essence, as a single firm

Consider the classic example of a monopsony - the very isolated coal mining town of the early 1900's. Owners of the mine would buy the only resource local citizens had - their labor - but because no other "buyer" of labor existed, the mine owners paid the workers less than they could earn in other, less isolated, towns. Because these towns were so isolated, the workers had no choice but to sell their labor at the price (wage) the mine owners offered. The mine owners, acting in their own self interest, paid each worker significantly less than the revenue produced by that worker.

Is MLB a monopsony? Let's examine some of the evidence:

1. MLB has a long-standing agreement among owners that young players must be drafted by individual clubs and must sign with the club that drafts them, or sit out one year of organized professional baseball. This means that, initially, only one buyer for player inputs exists. These contracts are valid for seven years. Even if a player makes it to the major leagues, he cannot re-negotiate his contract for three years. While some young players do make it to the major leagues early in their careers, it is conceivable that a young player might belong to one club for ten years before he could be bid away by a competing team.

2. The owners of MLB franchises have strict agreements over the number of firms in the industry (28) and the number of players that can be hired by each team (25). In fact, no new ballclub (and the additional inputs it requires) may be organized without complete consensus among all owners.

3. Players are paid less than they might if the player draft and contract system did not exist. Gill and Brajer1 have estimated the level of monopsony exploitation for non-free agents to be between .295 and .574. That is, these players were paid between 42% and 70% of what they might be worth in a competitive market. Players are also paid much less than the revenue they generate for teams. If we take one player, Barry Bonds, as an example of this last point, we can see that the disparity between salary and revenue produced can be quite high for star players. Jack Chambless2 has calculated that, based on Bonds' 1993 performance, he contributed over $9 million to his team's (the San Francisco Giants) revenues. Contrast this with Bonds' $4.2 million salary and we can see that Bonds generated gross revenues of $4.8 million.

Based on these points, at least some of the characteristics of a monopsony are manifest in the MLB labor market. A strong case can be made for the existence of monopsonistic exploitation by MLB owners; certainly this is true of young players and the MLB draft. Also, the very tightly controlled MLB market, in conjunction with the specialized nature of the input being employed, would seem to imply that owners are capable of wielding monopsonistic power over players.

So are MLB players overpaid? Are MLB owners acting against their own self-interest? If we rely on economic reasoning the answer to both these questions may in fact be no. In fact, MLB owners have reported record profits over the last few seasons (e.g., $214 million in 1989). And, based on what we know about monopsonies and monopsonistic exploitation, players do appear to be - believe it or not - underpaid by a significant amount.

QUESTIONS FOR DISCUSSION

1. What is a monopoly market?
2. What is a monopsony market?
3. What is monopsonistic exploitation?
4. How might MLB be a monopsony? How might MLB players be underpaid?

5. Based on the characteristics of a monopsony discussed above, determine which of the following are examples of monopsony power. Choose "B" if the buyer holds the monopsony or "S" if the seller holds a monopoly.

or A small liberal arts college employs more than 70% of the town's population.
or A local phone company offers only ATT long distance service.
or The local public utility.
or A major automobile manufacturer builds a plant in rural Ohio.
or McDonald's Corporation buys over 50% of all frozen french fries made in the United States.

1 Gill, A. & Brajer, V. (1994). Baseball stars and baseball cards: A new look at monopsony in major league baseball. Social Science Quarterly (75), 195-203.

2 Chambless, J. Poor underpaid millionaires. Wall Street Journal, July 5, 1994, p. 13.