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Problem Set #21. Suppose that each team in a league has a demand curve for generic advertising (a league-wide nonteam–specific campaign) equal to Q  1,000  5p. If there are 20 teams in the league, and ads cost $175 each, how many ads will the teams want to purchase as a group?Answer: This problem can be solved in two ways. Because league wide marketing campaigns are nonrival in consumption, we could the demand curves vertically (the intercept is multiplied by 20).Each team’s demand function isThus, the market demand curve isWhen p  175, the equilibrium quantity of ads purchased isAlternatively, one can assume that the price each individual firm will pay for an advertisement is p  $175/20  $8.75.2. Suppose that most of the teams in a given league are owned by individuals, while two are owned by corporations. If the profits of the individually owned teams rise, but the corporate owned teams remains flat, is it fair to say that this is in inferior ownership structure? Why or why not?Answer: It is probably not fair to suggest that corporate ownership is an inferior structure. The most likely explanation is that the corporation is using the sports team to maximize profits elsewhere in the corporation. For example, if the corporation is a media conglomerate, revenue sharing provides the company with the incentive to undercharge for its broadcasting rights lowering the profits of its sports team while increasing the profits of its broadcasting arm by the same amount.3. Suppose an owner pays $500 million to purchase a hockey team that earns operating profits of $50 million per year. The new owner claims that $200 million of this prices is for the players, which he can depreciate using straight-line depreciation in five years. If the team pays corporate profit taxes of 40 percent, how much does the depreciation of the players save the owner?Answer: The owner can claim a depreciation expense of $40 million per year ($200 million/5). The reduction of profits by $40 million, which would have been taxed at a rate of 40 percent saves the owner $16 million per year, or $80 million over the five year period.4. Would fans be better off if the government prevented media outlets such as Disney or local cable companies from owning pro sports teams?Answer: Not necessarily. The restriction will break a vertically integrated firm into separate upstream and downstream components. This may actually worsen the well-being of the consumer because the downstream firm will buy at an inflated monopoly price when it would buy at marginal cost if it were vertically integrated.5. One reason the Atlanta Braves do not maximize profit is because(a) they add to the profits of TNT.(b) they detract from the profits of TNT.(c) they do not play in a large city.(d) they profit from sponsorship by TNT.Answer: (a) The Braves do not charge TNT the full value of their broadcast rights. Doing so would just take money from one business that Time Warner owns and gives it to another. The theory of vertical integration suggests, in fact, that Time Warner will maximize profits if the Braves act like a perfectly competitive firm and set the price of broadcast rights equal to the marginal cost of providing them when it deals with TNT.6. The Florida Marlins of MLB recently shed most of their best players. In 2006, their payroll was less than one-tenth that of the New York Yankees. Would a team in England’s Premier League follow such a policy? Why or why not?Answer: The Marlins can afford to severely cut payroll because no matter how poorly they perform, they will still remain in MLB. A team in the Premier League would not engage in such a drastic slash in their payroll as a poor performance on the field during the season would relegate them to the minor leagues.Problem Set #21. Suppose that each team in a league has a demand curve for generic advertising (a league-wide nonteam–specific campaign) equal to Q  1,000  5p. If there are 20 teams in the league, and ads cost $175 each, how many ads will the teams want to purchase as a group?Answer: This problem can be solved in two ways. Because league wide marketing campaigns are nonrival in consumption, we could the demand curves vertically (the intercept is multiplied by 20).Each team’s demand function isp  200  0.2QThus, the market demand curve isp  4000  4QWhen p  175, the equilibrium quantity of ads purchased is175  4000  4QQ  956.25Alternatively, one can assume that the price each individual firm will pay for an advertisement is p  $175/20  $8.75.Q  1000  5p  1,000  5(8.75)Q  956.25 2. Suppose that most of the teams in a given league are owned by individuals, while two are owned by corporations. If the profits of the individually owned teams rise, but the corporate owned teams remains flat, is it fair to say that this is in inferior ownership structure? Why or why not?Answer: It is probably not fair to suggest that corporate ownership is an inferior structure. The most likely explanation is that the corporation is using the sports team to maximize profits elsewhere in the corporation. For example, if the corporation is a media conglomerate, revenue sharing provides the company with the incentive to undercharge for its broadcasting rights lowering the profits of its sports team while increasing the profits of its broadcasting arm by the same amount.3. Suppose an owner pays $500 million to purchase a hockey team that earns operating profits of $50 million per year. The new owner claims that $200 million of this prices is for the players, which he can depreciate using straight-line depreciation in five years. If the team pays corporate profit taxes of 40 percent, how much does the depreciation of the players save the owner?Answer: The owner can claim a depreciation expense of $40 million per year ($200 million/5). The reduction of profits by $40 million, which would have been taxed at a rate of 40 percent saves the owner $16 million per year, or $80 million over the five year period.4. Would fans be better off if the government prevented media outlets such as Disney or local cable companies from owning pro sports teams?Answer: Not necessarily. The restriction will break a vertically integrated firm into separate upstream and downstream components. This may actually worsen the well-being of the consumer because the downstream firm will buy at an inflated monopoly price when it would buy at marginal cost


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BU EC 385 - Problem Set #2

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