Salary Caps in a Model of Talent Allocation
One of the central externalities associated with large- vs. small-market teams is the potentially adverse effect of the market allocation of talent on competitive balance. Large-market teams are driven to buy more talent than their small-market counterparts, leading to long-lasting dynasties and perennial losers. Such an adverse effect on game uncertainty is likely to affect fans’ interest in the sport (under the Uncertainty of Outcome Hypothesis), and hence reduce league demand (Rottenberg 1956). To promote competitive balance, intervention by the Commissioner’s office may be warranted to override the free-market allocation. One competitive balance policy widely believed to have the ability to reallocate talent is a limit on team payrolls, known as a salary cap. While an effective salary cap will result in a deadweight welfare loss, this loss may be deemed worthwhile if the benefits associated with improved competitive balance more than offset the costs associated with the welfare loss.
KeywordsDeadweight Loss Social Surplus Competitive Balance National Basketball Association Marginal Revenue Product
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