Specifically, in Table 28-1 we see the empirical evidence presented by economist Gerald Scully to measure the difference between marginal revenue product and the wage rate (estimated salary).

Source: G.W. Scully, "Pay and Performance in Major League Baseball," American Economic Review, vol. LXIV, no. 6 (December 1974), p. 928.

Scully tried to take player quality into account by netting out the expenses relating to player development. He came up with a "net" MRP for players of three different qualities: mediocre, average, and star. Because team owners often expend $500,000 developing every player signed and because team owners cannot predict accurately which players will develop into stars, sometimes net MRP (ex post) is negative. If the baseball players’ market is purely competitive, the annual salary should roughly equal net MRP. In a monopsony situation, however, annual salary, on average, would be less than net MRP. The latter is exactly what Table 28-1 shows.

SALARY DETERMINATION: MONOPOLY AND BILATERAL MONOPOLY

We first assume that the players are unorganized and do not bargain collectively. The team owners, however, have formed a monopsony and agree that no team will attempt to bid away any other team’s players. They further agree not to raise wages. This is the simplest model that can be applied to the pre-free-agency baseball situation.

The marginal revenue product curve of the baseball team owners, taken as a group, is represented by MRP in Figure 28-1.

The marginal factor cost curve facing the team owners, taken as a whole, is MFC. The intersection of MRP and MFC is at A. The quantity demanded of baseball players is Q_m. The wage rate presented to baseball players is w_m. The amount of monopsonistic exploitation is the distance between A and O. The amount of monopolistic exploitation is the distance between A and B. Total exploitation is the vertical distance between B and C.

Now, what happens when the baseball players band together and form a monopoly in the sale of their services? This would create a situation called bilateral monopoly; in this case, it’s the factor market in which there is a single buyer and a single seller. We show it in Figure 28-2.

The marginal revenue product curve of the baseball team owners, taken as a whole, is represented by MRP. We draw a curve that is marginal to MRP and label it MR. MR is, in effect, a marginal revenue curve (for the monopoly seller of baseball players’ services), when we consider that MRP is the demand curve for baseball players’ services by monopoly team owners. Thus, MR is no different from any other marginal revenue curve in a monopoly situation.

The union of baseball players has supply curve of S. The curve marginal to that S curve is called the marginal factor cost curve, or MFC. The baseball team owners would like to set a wage rate of w_m, because this is where the team owners could obtain the profit-maximizing number of players, and it is determined by the intersection at point A of the marginal factor cost curve (MFC) and the marginal revenue product curve (MRP).

The union, however, acting as the sole bargaining agent for all the employees, would, if it were maximizing the equivalent of monopoly profits, want to set a wage rate of w_u. We determine the maximizing wage rate w_u by considering that the union is acting as a monopolist. Every monopolist will set output where MR = MC. What is marginal revenue in this case? It is the curve labeled MR, which is marginal to the demand curve for baseball players (MRP) by monopoly team owners. What is marginal cost? It is given by the supply curve of baseball players, or S. MR and S intersect at point B. That amount of baseball players’ services can be sold to the team owners at a price of w_u given by the team owners’ demand curve MRP.

All we can say is that, in a situation of bilateral monopoly, the agreed-upon wage rate is indeterminate, but it will be in between w_m and w_u. (The quantity of the players employed will also be indeterminate.) If we were to assume that the union is proprietary--privately owned for the purpose of making a profit--we would state that the union would attempt to attain w_u because that is the wage rate that maximizes the difference between total wages that are paid to employed baseball players and the minimum amount of wages required to bring this quantity of labor into the baseball playing market.

JOINT WEALTH MAXIMIZATION

Actually, there is a determinate level of employment at which both the players and the team owners maximize their joint wealth. If we assume that transactions costs are zero, the two groups would agree to employ the number of players at which the supply curve intersects the marginal revenue product at point E in Figure 28-2. At this point the two groups are not attempting to exploit one another; rather, they are conspiring jointly to exploit the spectators. There is a problem at point E, however. The problem is how wealth should be split between the group of players and the group of team owners.

This analysis indicates that the reason the baseball team owners complain about players’ salaries being "too high" is because there is a transfer of wealth from owners to players. From the standpoint of baseball observers, there would seem to be no reason to think it more "fair" that the owners get the funds in question rather than the players. Look back at the MRP estimates in Table 28-1. Those numbers were based on data from the late 1960s. If we assume that wages have kept pace with consumer prices, the player salaries would be about four times the MRP estimate today. Indeed we see most "star" players earning over a million dollars today, so Scully’s estimates appear to have been reasonably accurate. In fact, he estimated that during the late 1960s Hank Aaron was worth about $600,000 per year and Sandy Koufax was worth about $725,000 per year, which would translate to about $2.5 to 3 million per year today--a number consistent with the earnings of our current "superstars."

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