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Baseball Economics 101

Key Economic Concepts:

• Factors of Production
• Incentive
• Marginal Resource Product
• Profit Maximization

Description:

As any baseball fan can tell you, the New York Yankees have won three of the last four World Series championships. The Yankees' recent success--as well as the success of other big market, high revenue teams--has led many to question whether smaller market teams can compete in Major League Baseball (MLB). In fact, in 1999, the Yankees had revenues of $176 million, the most of any team in sports--and more than the revenue of three other MLB teams (Milwaukee, Montreal and Minnesota) combined! Many baseball writers (who may or may not know very much about economics) have written that our national pastime may be threatened by the big market, high revenue teams like the Yankees (or the Los Angeles Dodgers, the Boston Red Sox or the Arizona Diamondbacks) and that smaller market teams (e.g., the Kansas City Royals or the Pittsburgh Pirates) cannot compete for the high salaried free agents (e.g., Randy Johnson or Mike Piazza) necessary to win championships. In fact, some writers claim that many MLB teams are actually not profitable for the team owners. Are these claims true? Are MLB teams losing money? Are MLB owners looking to dump unprofitable teams on unsuspecting investors? Are MLB players grossly overpaid? This lesson will help you answer these and other questions.

Lesson Objectives:

Students will:

• State the average salary of a Major League Baseball (MLB) player.
• Identify MLB revenue sources in addition to ticket sales.
• Use economic reasoning to refute the argument that MLB players are overpaid.
• Describe how MLB team owners are acting in their own self-interest by not selling teams that appear to be losing money.

Introduction:

As any baseball fan can tell you, the New York Yankees have won three of the last four World Series championships. The Yankees' recent success--as well as the success of other big market, high revenue teams--has led many to question whether smaller market teams can compete in Major League Baseball (MLB). In fact, in 1999, the Yankees had revenues of $176 million, the most of any team in sports--and more than the revenue of three other MLB teams (Milwaukee, Montreal and Minnesota) combined!

Many baseball writers (who may or may not know very much about economics) have written that our national pastime may be threatened by the big market, high revenue teams like the Yankees (or the Los Angeles Dodgers, the Boston Red Sox or the Arizona Diamondbacks) and that smaller market teams (e.g., the Kansas City Royals or the Pittsburgh Pirates) cannot compete for the high salaried free agents (e.g., Randy Johnson or Mike Piazza) necessary to win championships. In fact, some writers claim ^[1] that many MLB teams are actually not profitable for the team owners.

Are these claims true? Are MLB teams losing money? Are MLB owners looking to dump unprofitable teams on unsuspecting investors? Are MLB players grossly overpaid? This lesson will help you answer these and other questions. (NOTE: this lesson updates a 1997 NetNewsLine activity titled "Underpaid Millionaires?" [www.econedlink.org/lessons/index.php?lesson=NN146] which focused exclusively on players' salaries.)

Pre-Test

Before beginning the lesson, please take the short Pretest to see what you already know about the economics of baseball. Print out your answers and save them to compare with your answers on the posttest.

Process:

Activity 1

MLB Salaries and Wins and Losses

In 1991, the average MLB player's salary was $1 million. What is the average today? Does paying high salaries always translate into championships (or even winning seasons)? This activity will shed some light on these questions.

First, you'll need to print out this worksheet. Next, use the 1999 payrolls ^[2] [www.usatoday.com/sports/baseball/mlbfs15.htm ^[2] ] of all 30 MLB teams to fill in the worksheet. Be certain to use the "average team salary" in the worksheet. Next, fill in the 1999 won-loss records for the 16 teams in the National League ^[3] [www.baseball-almanac.com/yearly/yr1999a.shtml ^[3] ] and the 14 teams in the American League ^[3] [www.baseball-almanac.com/yearly/yr1999a.shtml ^[3] ]. Finally, enter the salary data and the team won-loss records into this worksheet. Are the teams with the largest payrolls the most successful? Do larger market teams (with the high revenues needed to pay high salaries) have an advantage over smaller market teams? Go back to the Excel document you created with team salaries and wins and losses. You are going to rank teams in each league by the numb www.econedlink.org/lessons/docs_lessons/75_MLB_salaries2.pdfer of wins in 1999 and then compare their average salaries. Follow these instructions carefully:

• First, use your mouse to highlight the "Wins (1999)" column for just the American League (AL).
• Next, use the "Data" command menu (at the top of the Excel window) to select "Sort."
• You will be prompted to "expand the selection." Answer 'yes' and choose "descending order" from the menu. (NOTE: If you have done this correctly, the New York Yankees--with 98 wins--should now be the first team on the AL list.)
• Repeat this process for the National League (NL). (NOTE: If you have done this correctly, the Atlanta Braves--with 103 wins--should now be the first team on the NL list.)
• You may want to print out your Excel worksheet and refer to the printout as you answer the following questions:

1. Only two of the top seven teams in the American League had an average player salary lower than the MLB average. Which teams were these? [Oakland ($893,628) and Toronto ($1,711,8970]
2. Only one of the bottom seven teams in the American League had an average player salary higher than the MLB average. Which team was this? [Baltimore ($2,922,307)]
3. Only two of the top eight teams in the National League had an average player salary lower than the MLB average. Which teams were these? [Cincinnati ($1,143,500) and Pittsburgh ($739,922)]
4. Only two of the bottom eight teams in the National League had an average player salary higher than the MLB average. Which teams were these? [Colorado ($2,148,648) and the Chicago Cubs ($2,075,569)]
5. What do these results seem to imply? [Those MLB teams with higher average salaries tend to win more games than teams with lower average salaries. This is not always the case, however, as the correlation between average salaries is higher in the AL (.7364) than in the NL (.4871), implying that the relationship between deep pockets and big wins is greater in the AL.]

Activity 2

The number of games (or World Series Championships) a team wins is just one measure of success for MLB team owners. Most MLB team owners, like other business owners, are concerned about a great many things including bottom line profitability. While it is important to win games (as this puts fans in the seats at stadiums), teams receive revenue from a number of sources in addition to ticket sales. Use Forbes sports team valuations page ^[4] [www.forbes.com/2001/03/29/0329best50.html ^[4] ] to identify some other forms of revenue a MLB team has. [Home attendance, venue (stadium) revenue, media (TV, radio, cable) revenue.

Use the table in the Forbes article to answer the following questions:

1. How many MLB teams lost money (had a negative "Operating Income") in 1998? [14 had negative operating incomes; range: Dodgers (-$11.7 million) to Angels (-$200,000)]
2. Year-to-year operating income is only one way to measure an owner's return on his or her investment. Look at the first and second columns of the Forbes chart. The first column indicates how much the franchise is currently worth. The second column indicates the percentage change (from 1998 to 1999) of the value of that franchise. How many teams increased in value from 1998 to 1999? [21 out of 28 teams reporting.]
3. Take the case of the New York Mets. How much money (Operating Income) did the Mets lose in 1998? [$5.2 million]
4. What is the estimated current value of the team (if sold now) for owners Nelson Doubleday and Fred Wilpon [$249 million]
5. Did the team's value increase from 1998? [Yes, by 29%]
6. What was the team worth in 1998? [Divide $249 million by 1.29 (represents the 29% increase in 1999) and get $193 million]
7. The dollar value of the Mets increased by how much from 1998 to 1999? [$249 million - $193 million = $56 million]

What does this analysis imply? Are owners crazy to keep holding onto teams that are losing money? [Even though teams might be losing money from year-to-year, owners continue to realize returns to their investments in the form of increased team values. Thus owners aren't crazy to keep a team that loses at the gate. In the case of the Mets, the gain in team value exceeded operating losses by almost $51 million. Not a bad return!]

Activity 3

What about those outrageous player salaries in the Major Leagues? Ten million dollars per year, and more —to play a kids' game. That's insane! Perhaps the owners are crazy after all! (NOTE: this activity will shed a little light on this complex economic problem, but if you are interested in reading more about this issue, please see the NetNewsLine activity " Underpaid Millionaires?" [www.econedlink.org/lessons/index.php?lesson=NN146]).

The owners of businesses (in this case, the owners of baseball teams) buy factors of production ^[5] [www.investorwords.com/cgi-bin/getword.cgi?5566&factors%20of%20production ^[5] ] from individuals who own these factors. For example, the owner of Tastee Tacos buys the factor "labor" [www.cyberteach/glossary.php?#L] from the high school students who assemble the tacos for her. The owner also buys the factor "capital" (www.cyberteach/glossary.php?#C] when she buys the grill used to cook the chicken for the fajitas. So it is with MLB owners; they buy various factors that go into the 'product' (a MLB baseball game) they sell. MLB players possess a very specialized form of 'labor' (hand-eye coordination, ability to hit a ball 500 feet) that they sell to the owners of their teams.

Are these players overpaid for their labor? An economist would say that owners should pay employees close to the value of the employees' contributions to the company. Economists call contribution the "Marginal Revenue Product" of an employee. This describes an employee's contributions to the final good or service (in this case, an MLB baseball game). What is a player's contribution to the 'bottom line' of an MLB franchise? One way to measure this "marginal product" is to examine the increased revenue a player brings to his team. This might be through more team wins or through more excitement generated by having a great player on your team.

Let's consider the case of Mark McGwire ^[6] [www.members.tripod.com/~Phil_Reich_Art/index-63.html ^[6] ] of the St. Louis Cardinals. Everyone knows that "Big Mac" has created a renewed interest in MLB baseball with his tremendous home runs and record-setting seasons. In 2001, McGwire earned a salary of $11,000,000. But has he earned his high salary from the Cardinals? Let's see.

1. 1996 was the last full year before McGwire came to the Cardinals. What were the St. Louis Cardinals ^[7] ' total team revenues for 1996? [$69.8 million] What was the Cardinals' franchise value ^[7] [www.baseball1.com/bb-data/96-biz.html ^[7] ] in 1996? [$134 million]
2. 1998 was McGwire's first full season with St. Louis. The St. Louis Cardinals' total team revenues for 1998 were $97.8 million. What was the Cardinals' franchise value ^[8] [www.reds.enquirer.com/2000/02/06/red_griffey_payoff_is_in.html ^[8] ] in 1998? [$205 million]
3. How much did Cardinal revenues increase in 1998 over those of 1996? [$97.8 - $69.8 = $28 million]
   How much more was the franchise worth in 1998 versus 1996? [$205 - $134 = $71 million]

Conclusion:

Has Mark McGwire earned his salary? Certainly he was not the only reason the Cardinals improved their revenues and increased their franchise value from 1996 to 1998, but McGwire accounted for much of this growth. Did he earn his "marginal revenue product?" In fact, McGwire probably was paid much less than he has meant to the St. Louis franchise and its owners, making much less than his marginal revenue product. More than nine million dollars is not enough?!? It would be hard to convince the kids at Tastee Taco of this, but that's why a little economics is so helpful here.

Assessment Activity:

Well, what have we learned? Let's retake the little test we took at the beginning. Pull out your pretest and compare those answers with the interactive Post Test.

Links Used:

1. ^{^} "Six Teams Out" - (www.slate.com) An article on how Major League Baseball's owners are upset with the game's economic structure.
2. ^{^ ^} "Player Salaries" - (www.usatoday.com) 1999 top player salaries in Major League Baseball.
3. ^{^ ^ ^ ^} "National League" - (www.baseball-almanac.com) This site gives you a brief history of the 1999 American League.
4. ^{^ ^} "Baseball's Top 50" - (www.forbes.com) Provides stats on the value of the top 50 baseball players.
5. ^{^ ^} "factors of production" - (www.investorwords.com)
6. ^{^ ^} "Mark McGwire" - (members.tripod.com) This site provides you with a bibliography of Mark McGwire.
7. ^{^ ^ ^} "St. Louis Cardinals" - (www.baseball1.com) This site provides you with the 1996 team financial statements.
8. ^{^ ^} "Griffey Payoff is in the Cards" - (reds.enquirer.com) This 2000 article discusses the great monetary gains made by the St. Louis Cardinals when Mark McGwire broke the homerun record. It also discusses how the Reds hoped to equal those successes with Ken Griffey Jr.

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