The Econom

ics of SportsLeeds von A

llmen

fifTh

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ion

GLobAL EdiTionG

Lob

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This is a special edition of an established title widely used by colleges and universities throughout the world. Pearson published this exclusive edition for the benefit of students outside the United States and Canada. if you purchased this book within the United States or Canada you should be aware that it has been imported without the approval of the Publisher or Author.

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for these Global Editions, the editorial team at Pearson has collaborated with educators across the world to address a wide range of subjects and requirements, equipping students with the best possible learning tools. This Global Edition preserves the cutting-edge approach and pedagogy of the original, but also features alterations, customization, and adaptation from the north American version.

fifTh EdiTion

Michael A. Leeds • Peter von Allmen

The Economics of Sports

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Chapter4 • MonopolyandAntitrust 139

resulting in prices of $6 and $10, respectively. The team will sell out the popular game and sell 6,000 tickets to the less popular game. Total revenue for the two games is $136,000. The graph indicates that if the team tried to sell tickets to the less popular game for $10, most of the seats would go unfilled. Similarly, if the team charged only $6 for the popular game, it would sell the same number of tickets as at the higher price, but make 40 percent less in revenue. Suppose that instead of charging two prices, the team charged a single intermediate price, such as $8, for both games. We can easily show that such a strategy results in a price that is too high for the unpopular game and too low for the popular game.17 At a price of $8, the more popular game still sells out, but revenue falls from $100,000 to $80,000; for the less popular game, attendance falls to 4,000, resulting in revenue of just $32,000. Thus, overall revenue from charging a single price of $8 is $112,000, $24,000 less than the two-price scheme. This analysis is far from a theoretical abstraction. Barry Kahn, CEo of Qcue, a firm that provides computer software that allows teams to run dynamic pricing schemes, says that teams using this strategy have increased revenue by an average of 30 percent for high-demand games and 5−10 percent for low-demand games.18

Withtheseadvancedpricingstrategies,teamsmaximizeprofitbymaximiz-ing ticket revenue. As Dan Rascher et al. note, however, there are other revenue

17The equation for D0 is Q = 12 - P. The equation for D1 is Q = 20 - P.18Patrick Rishe, “Dynamic Pricing” (2012).

p ($ per ticket)

Q (thousands of tickets)

0

2

D1

D0

MR0 MR1

MC

4 6 10 12

6

8

10

12

FIgure 4.3 Variable Ticket Pricing

A team facing differential demand for its games (D0 and D1) maximizes profits by charging $10 per seat for the more popular game and $6 per seat for the less popular game, as opposed to a single price of $8 for both games.

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140 Part2 • TheIndustrialOrganizationofSports

streams to consider. Parking and concessions are complements to tickets. As such, the team may do well to set ticket prices lower than would seem optimal because fans spend money on other goods once at the game.19 There are limits to this strat-egy, however, as total revenue from ticket sales begins to drop off quickly once marginal revenue becomes negative. For example, in the graph, at a price of $2 per ticket the less popular game will be a sellout. Lowering the price from $6 to $2, however, reduces ticket revenue from $36,000 (+6 * 6,000) to $20,000 (+2 * 10,000).

Bundling

Inadditiontochargingfansforindividualgames,teamscanincreaserevenuebybundling games together. With bundling, a consumer who wants to buy good A must also buy good B (or perhaps many more goods, as in the case of season tickets). With product bundling, firms take advantage of differing demand across products to capture some of the consumer surplus that might otherwise accrue to buyers. To illustrate this point, consider Phil a huge Cubs fan who particularly likes to see them play their cross-town rivals, the White Sox. But because so many other Chicagoans feel the same way, tickets can be hard to find. Fortunately for Phil he can get tickets to a White Sox game—and highly desirable games against the Cardinals and Detroit Tigers as well—by purchasing a Cubs six-game pack. The six-game pack allows Phil to buy tickets to the White Sox game as long as he also purchases tickets to five other games, including a Wednesday afternoon game against the Pittsburgh Pirates for which demand is likely much lower than for the White Sox game.20

To see how this pricing scheme benefits both Phil and the Cubs, let’s assume that a ticket for the White Sox game costs $30. Phil is willing to pay $100 to see a Cubs–White Sox game, but he would only pay $25 to see any other Cubs game. If theticketsweresoldseparatelyatthepriceof$30,hewouldgototheWhiteSoxgame and receive a surplus of $70, but would not buy a ticket to the other games. Suppose now that Phil can see the Cubs–White Sox game only if he buys a six-pack of tickets. Unlike variable ticket pricing, bundling does not rely on setting differ-entpricesforeachgame.Instead,itreliesonthelargesurplusconsumerswouldreceivefromseeingaspecificgame.Ifallticketsaresoldattheregularpricebutmust be purchased in a group of six, tickets to the hypothetical six-game set cost $180 [6 * $30]. Phil values the six tickets at $225 ($100 for the White Sox game and $25 for the other five games). At a price of $180, he is better off making the pur-chase because he still receives a surplus of $45. Even though he experiences a loss of $5 on the five less-popular games, the loss is more than offset by the surplus he receives from seeing the White Sox game. The Cubs are better off as well because they sell tickets to six games instead of only one. With the marginal cost of Phil’s attendanceattheseextragamesatorclosetozero,theCubs’profitsalsoincrease.

19Dan Rascher et al., “Variable Ticket Pricing in Major League Baseball,” Journal of Sport Management, vol. 21, no. 3 (2007), pp. 407–437. They base this analysis on the work of Rodney Fort, “owner objectives and Competitive Balance,” Journal of Sports Economics,” vol. 5, no. 1 (February 2004), pp. 20–32.20Cubs.com, Six Game Pack, 2012, at http://chicago.cubs.mlb.com/chc/ticketing/sixpacks.jsp, viewed March 20, 2012.

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Chapter4 • MonopolyandAntitrust 141

price discrimination and two-part pricing

Inourdiscussionofvariableticketpricing,dynamicpricingandbundling,teamsused advanced pricing strategies based on differences in the perceived quality of the games by a given consumer. We now move on to a different strategy that relies on teams’ identifying differences in willingness to pay for the same game.

Recall that in Figure 4.1, a single monopoly price led to a deadweight loss of area BCG, and left consumers with a surplus of area ABF. We know that consumer surplus is the extra benefit that consumers receive because the firm charges a singleprofit-maximizingpriceforallunitsitsells.Often,firmschargeasingleprice to all consumers because they have no way to determine which consumers are willing to pay more, and consumers have no incentive to reveal their greater willingnesstopay.Ifamonopolistcouldsortconsumersbytheirwillingnessandability to pay and set prices accordingly, it could capture some or even all of the consumer surplus. As we will see, such a pricing strategy also reduces or elimi-nates the deadweight loss associated with a single monopoly price. Economists call charging different prices to different consumers based on their willingness to pay price discrimination. Unlike the common use of the word discrimination, which refers to actions based on prejudice, price discrimination has nothing to do withdislikeforaparticulardemographicgroup.Instead,afirmpricediscrimi-nates when it charges more to customers who are willing and able to pay more. on the surface, charging a higher price to wealthy customers than to poor con-sumers sounds like the fair thing to do. We shall see, however, that firms that price discriminate seldom have such altruistic motives and that price discrimina-tion does not leave consumers better off.

perFect prIce dIscrIMInatIon If the Panthers know exactly how muchDebbie, Bill, Jeff, and Kathleen are willing and able to pay, they can extract their consumer surplus by charging each person exactly what he or she thinks the ticket is worth. By charging Debbie $40, Bill $20, and Jeff $10, the Panthers turn all their consumers into marginal consumers.21 All the consumers are now just willing to pay for the tickets because what was once their consumer surplus is now additional profit for the Panthers.

By treating each additional consumer like the marginal consumer, the Panthers no longer charge a lower price to everyone when they want to sell more tickets. The process of charging each consumer the maximum that he or she is willing to pay is known as perfect price discrimination. When the Panthers perfectly price discriminate, their marginal revenue is the price of the last, cheapest ticket that they sell. The marginal revenue of selling a ticket to Bill is thus$20,whilethemarginalrevenueofsellingaticket toJeff is$10. Intermsof Figure 4.1, if the Panthers can perfectly price discriminate, their MR curve coincides with their demand curve. The Panthers now sell the same number of tickets as a perfectly competitive industry, and total surplus grows to ACE. Social

21Technically, the Panthers would have to charge $39.99, $19.99, and $9.99 to be sure that Debbie, Bill, and Jeff buy tickets. We round off for ease of exposition.

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142 Part2 • TheIndustrialOrganizationofSports

well-beingisonceagainmaximized,astheperfectlyprice-discriminatingmonop-olist acts in an economically efficient manner. Consumers, however, do not receive any of the increase in social well-being. By charging all consumers exactly what the ticket is worth to them, the Panthers claim Debbie and Bill’s consumer surplus for themselves. By charging all fans the maximum price they are willing and able to pay, the Panthers capture the entire area ACE in Figure 4.1 as revenue.

personal seat lIcenses As a general rule, firms do not have enough informa-tion to extract all the consumer surplus. Few firms know exactly how much each consumer is willing and able to pay for an item. However, firms have other ways to extract at least part of the consumer surplus. one such method is two-part pricing. As its name indicates, two-part pricing involves two distinct segments—a fixed component and a variable component that changes with the amount of output the consumer purchases. Personal seat licenses (PSLs) are a form of two-part pricing that has become particularly popular in the NFL. They were first introduced by the Carolina Panthers to help finance the construction of Ericsson Stadium (now Bank of America Stadium) in 1993.22

The idea of a PSL is very simple. A person pays a fixed fee for the right to buy season tickets for a given period of time. This allows teams to capture a large portion of the consumer surplus and deadweight loss that ordinarily results from a monopoly. We can think of this strategy as a two-part process. First, the Panthers can eliminate the deadweight loss by charging the competitive price for season tickets and selling the competitive quantity. The lower price and higher quantity restore consumer and producer surplus to their competitive levels. The Panthers then exert their monopoly power by charging a fixed PSL fee that allows them to claimsomeoftheconsumersurplusthattheirfansenjoy.IfthePanthersknewexactly how much consumer surplus the typical fan enjoyed, they could charge a PSL fee that extracted almost all of his or her surplus. This would leave the fan just willing to buy the season ticket. Figure 4.4 shows the demand curve for a typical fan(consumer).Insteadofchargingthemonopolyprice(pm), the team can increase profitsbyutilizingatwo-partprice.Thevariableportionofthetwo-partpriceiszero,asthePantherschargethecompetitivepricefortheticket(whichis0inoursimple world where MC = 0). The fixed portion of the price is the cost of the PSL. If  all fans have the same preferences, as described by the demand curve inFigure 4.4, the team sets the PSL fee equal to the shaded area and consumer surplus fallstonearlyzero.ThePantherscouldthuskeepallthebenefitsofacompetitivemarketforthemselves.Ifconsumersdonotallhavethesamepreferences,thetaskofthe team is more complicated. A low PSL fee leaves some surplus for high-demand consumers. A high PSL fee leads low-demand consumers to forgo the PSL.23

22The argument that follows is based on Roger Noll and Andrew Zimbalist, “Build the Stadium—Create the Jobs!” in Sports, Jobs, and Taxes, ed. by Roger Noll and Andrew Zimbalist (Washington, D.C.: BrookingsInstitutionPress,1997),pp.20–25.23For more on the role of PSLs in stadium funding, see for example, Robert Baade and Victor Matheson, “Have Public Finance Principles Been Shut out of Financing New Stadiums for the NFL?” Public Finance and Management, vol. 6, no. 3 (2006), pp. 284–320.

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Chapter4 • MonopolyandAntitrust 143

QuantIty dIscounts Another way for firms to increase profit is to offer a menu of price–quantity combinations and to let consumers choose the combination they most prefer. As with perfect price discrimination, this allows producers to charge prices that reflect the intensity of the consumers’ desire. Teams often offer an array of choices based on quantity.

Quantity discounts take advantage of the team’s knowledge that—assuming a given quality of games—fans’ marginal utility from consuming a sporting event declines with the quantity of games they attend. While the team does not know exactly what the fan is willing and able to pay for each game, the team knows that the fifth hockey game is worth less than the first and the twenty-fifth is worth less still. Many teams, particularly those with longer seasons, offer a variety of partial- and full-season ticket plans in which the cost per ticket is lower than the cost of buying each ticket individually.

segMented Markets Sometimes, the Panthers may know nothing about indi-viduals, but they know that some groups are less willing or able to pay. For exam-ple, the Panthers may know that students on the whole have less disposable income and as a result are more sensitive to changes in price than are middle-aged adults.24 If thePantherscanseparatethestudentmarketfromthenonstudentmarket(e.g.,byrequiringstudentstoshowtheiruniversityIDcards),thenthey

24Seniorcitizenscompriseanothergroupthatfirmsfrequentlyfeelismoresensitivetoprice.

$ price A

Bpm

F

D

C Qm

EMC

MR Q (quantity of tickets)

FIgure 4.4 A Two-Part Price

A two-part price consists of a fixed fee and a per-unit price. In this case, the firm attempts to set the fixed fee equal to the shaded area ACE, and the per-unit price is zero. Deadweight loss is eliminated and consumer surplus falls from BAF to zero.

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