The Baseball Economist: The Real Game Exposed (31 page)

The third condition necessary for price discrimination is the ability to prevent resale of the product. If resale is possible, the low-price purchasers of the product can compete with the producing firm. A low-price consumer may be willing to sell his product to a high-price customer at a price less than what the monopolist would charge. If the monopolist cannot prevent this type of sale, then its price discrimination strategy will fail, because high-price customers will simply purchase their products from low-price consumers.

MLB can, and does, charge different franchise fees for expansion franchises. But what if there is a city that values a new team more than an expansion city? It is possible in this situation that a higher-valuing city might induce the owner of the new team to move to that city, and MLB teams have been known to move cities. However, this movement is rare, as only one MLB team has switched cities since 1971—the Expos moved from Montreal to Washington, DC, to become the Nationals. Also, it is highly unlikely that MLB would approve the move of a team they had just created so that this new owner could capture extra profits. All moves require at least two-thirds approval from the owners. It would be odd that the owners would approve a sale to a low-demand city, if another city was willing to pay more for a new baseball team. The owners can generate more revenue by putting the team in the more valuable market.

It seems that MLB meets all of the conditions necessary for it to price discriminate, if it is a monopoly. Therefore, when judging the harm done from any monopoly power, we ought to view MLB as a multi-price monopolist, which is not nearly as bad as the traditional single-price monopolist.

A multi-price monopolist lessens the most undesirable feature of single-price monopoly: the underproduction of a product valued by consumers. The profits earned by monopolists are not undesirable. While some people who purchase the product pay a higher price for the product than they would under a perfectly competitive market structure, every consumer is paying a price equal to or less than their willingness-to-pay for the product. The additional revenue gained by the monopolist is not a net loss to society, since consumers who do consume the product at a higher price value the consumption of that product at the higher price. These consumers would be better off if they could purchase the product at a lower price, but the happiness lost to the consumer is gained by the producer. The consumers’ loss exactly equals the gain to the producer; thus, society is no better or worse off from this transfer.

The important distinction between the two models of monopoly lies with the underproduction of the desired product. When the single-price monopolist fails to supply consumers who are willing to pay a price greater than the additional cost of production, the firm is producing too few goods. This represents deadweight loss; consumers who would gladly pay for a product are not able to consume it, but no one captures the potential gains from trade. Everyone loses from the nonproduction of these additional units, but no one gains. This is simply the by-product of the monopolist’s decision to earn higher profits by concentrating on high-price customers.

The single-price monopolist must pick one price, and the point at which it will maximize profits will leave some willing customers empty-handed. The multi-price monopolist does not have to choose between selling to a few high-price customers or many low-price customers; it can sell to both types of consumers at different prices. It may not seem perfectly fair, but the multi-price system does fundamentally serve customers.
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That is to say, a multi-price monopolist maximizes profits in a way that enables him to help society as he helps himself, in a way the single-price monopolist cannot achieve. With perfect price discrimination, each unit sells for the price the consumer is willing for pay for each unit; a model followed by certain online airfare agents. The multi-price monopolist does not have to restrict quantity to maximize profits as the single-price monopolist must do. The only difference in outcomes between perfect competition and a
perfectly
price-discriminating monopolist is that the former generates no profits for producers while the latter eliminates consumer gains from purchasing the product at a bargain price. Economists do not pick winners and losers in terms of who gets revenue, just allocation of outcomes; and the perfectly price-discriminating monopolist outcome is just as desirable at the perfectly competitive option that economists treasure so dearly.

If MLB is a monopolist, it is a price discriminating monopolist. Assuming that self-interested owners who are interested in maximizing profits— I think few will deny the appropriateness of this assumption—run MLB, they ought to be engaging in price discrimination in their provision of baseball.

It seems that the quantity of teams is the only way MLB can adjust its output. In this case MLB will expand its teams into markets as long as the revenues from running a team in the town exceed the cost, and MLB will set its expansion fee according to each locale’s profitability. Each team prices its product according to the local demand for baseball, as evidenced by the differing ticket prices across baseball teams. In 2005 the average ticket price was about $22, with a range of $14 in Kansas City to $46 in Boston.
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MLB can set expansion fees based on the estimated revenues according to the potential demand. The Kansas Cities of the country would pay lower fees while Bostons would pay a much higher fee. Given that MLB has the ability to price discriminate, it has no incentive to restrict its output of baseball below the competitive optimum; because doing so would require ignoring uncaptured revenue. This is not what owners tend to do.

If MLB has some monopoly power, this does not mean baseball fans necessarily suffer from the typical abuses associated with monopoly. The most commonly applied model of monopoly, the single-price monopolist, is associated with the underproduction of its product. However, the single-price model doesn’t fit MLB. MLB can easily sell baseball to different markets at different prices. Price discrimination by multi-price monopolists leads to higher profits for owners, but also more games at acceptable prices for fans. In fact, the output of baseball should not differ considerably from the economist’s benchmark of perfectly competitive output. Contrary to our country’s great prejudice against monopolies, the extent to which MLB is one turns out not to be problem at all.

16

Expansion and the Invisible Hand

—JOSEPH SCHUMPETER
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MLB is the only league providing top-level baseball to fans in the U.S., so it is easy to begin the analysis of MLB using standard microeconomic models of monopoly that I have discussed. However, monopolies simply do not pop up into existence to impose their wrath on society in market economies. A business cannot become a monopoly by declaring itself to be one. Any firm that attempts to act like a monopoly will fail without some help from outside forces or strange internal forces inherent to that particular industry. Acting like a monopolist—raising prices and restricting output—encourages rival firms to enter the market, cut prices, and steal customers, and they will do so as long as they can.

Given the openness of the American economy, how is it possible that MLB is the only producer for major-league-level baseball in America? Is there some artificial or natural barrier to entering the baseball market? Or is baseball not acting like a monopolist, thereby creating no room for entry by potential competitors? One of these outcomes must be true. The answer lies in the history of MLB expansion.

Let us take a moment on what competition really is. The economic theory of
perfect competition
is based on three simple conditions:

If these conditions prevail in a market, that market will guide self-interested sellers to produce the output consumers desire at the lowest sustainable price. In contrast to the perfectly competitive model a monopoly results from these three conditions:

The first two assumptions of perfectly competitive markets are clearly not met in the American baseball market. Though we have many buyers, there is only one seller (MLB), and there are no competing baseball leagues. If MLB is the only producer of baseball, how can the baseball market provide fans with the baseball they want? There is no competition in the baseball market to restrain MLB from acting like a monopolist. So, again, there is a barrier to entering the baseball market—and we have more inferior baseball than we would otherwise—or some competitive pressure exists that forces MLB to produce good baseball.

Barriers to entry take two forms: artificial and natural. Artificial barriers, the most common, typically come from the government. Government actions by the legislature, judiciary, and executive branch can limit competitive pressures in a market. The most blatant example of artificial monopoly protection in the United States is the U.S. Postal Service. Since the mid-nineteenth century the post office has been the sole provider of everyday mail in the United States. Companies that seek to compete in everyday mail delivery are barred from doing so by law. This permits the post office to operate with the efficiency of . . . well, the post office—slow, expensive, and unreliable. While numerous providers of express mail such as FedEx and United Parcel Service would gladly compete with the post office in the distribution of mail, they are barred from doing so. Most artificial protections are a bit subtler. Tariffs on imported goods prevent foreign producers from competing with domestic producers not subject to the tariff. Like the post office, the tariffs limit the competitive pressures from outside producers.

The baseball antitrust exemption is not a barrier to entry into the baseball market. Any group of individuals may legally provide baseball to consumers without violating the antitrust exemption. The antitrust exemption merely gives legal protection to MLB if someone decides to sue the league for violating antitrust laws. MLB cannot seek legal remedies to protect it from competitors.

Perhaps the public subsidy of ballparks by localities is an artificial barrier to entry into baseball markets. Most MLB stadiums receive substantial public funds, and similar funding might not be available for competing teams. While the city of New York might support building new stadiums for the Yankees and Mets, New Yorkers would likely be less sympathetic, if not hostile, to subsidizing a new team in a new league. To survive, the teams in the new league would have to earn revenues sufficient to cover the costs of operation, and the league would have to put a product of similar quality on the field. The revenues needed to cover the cost of operation for a new team would include the everyday costs of running the team plus the rent on a new stadium. Taxpayer-subsidized stadiums would give MLB teams an advantage in signing talent over teams without subsidized facilities. The profits from running a baseball team, or revenues earned beyond the costs of operation, would be less to potential competitors, who would have to spend a portion of their earnings on facilities. MLB teams would therefore have more earnings available to sign talent. In this case, the profit motive would not be sufficient to induce entry by competitors.

This argument has two problems. First, it does not apply to cities without current MLB teams. Teams in competing leagues may be just as successful at extracting public subsides as MLB if they promise to bring major-league-level baseball to town. Plus, even if the costs of operating a team are higher in a city without an MLB team, the new team doesn’t have to worry about its fans migrating to a crosstown MLB rival. A slightly inferior product may still yield sufficient revenue for the owner to purchase major-league talent. This puts these teams in a rival league on competitive footing with MLB teams.

Second, the history of competing leagues does not reveal any public bias toward the public funding of stadiums for new leagues. Many of the teams in the United States Football League (USFL), which competed with the NFL in the mid-1980s, played in publicly financed stadiums. In fact, many USFL teams shared stadiums with NFL teams. History shows that the public’s willingness to subsidize teams extends beyond the dominant league brand. The point here is not that MLB teams could share stadiums with rival league teams—I think this would be highly unlikely—but that the public does not seem averse to subsidizing major sports teams from leagues other than the dominant existing league. It seems as long as a new league promises to pursue top-level talent, as the USFL did in football, citizens will subsidize the new teams. So public subsidization of stadiums doesn’t seem to be much of a barrier to entry in the baseball market.

So if there is no artificial barrier, perhaps there is a natural one. A natural monopoly arises as a result of the declining cost structure of an industry, which experiences extreme “economies of scale” in production. This means a producer can produce additional units of the product more cheaply than any other potential producer. Baseball, like the other major sports, fits this model quite well.

Starting a league is quite an expensive endeavor that requires heavy up-front investment to have any chance of success. Adding the first few teams is much more expensive than the last few teams, due to the high start-up costs. Therefore, the cost for the new league of supplying teams to meet the unmet market demand is greater than the cost of adding teams to the current league. Say the market could bear ten more teams. While a new league could enter the market to fill this gap, the incumbent league could easily counter by adding ten new teams to its league at a lower cost, thereby bankrupting any potential entrants. The rival league’s teams cost more than the existing league’s teams. If potential rivals have knowledge of the market, no firm will enter the market, and the incumbent league can act as a monopolist. So, in this special case, a monopoly can exist naturall
y
in the market without aid of any artificial entry barriers.