Question

Using out two-team model, graphically demonstrate that the marginal revenue (MR) from hiring talent is equal across large and small revenue markets in equilibrium. In the same graph, show and clearly label revenue imbalance, competitive imbalance and payroll imbalance.

Hint: You should use a two-team model (one large revenue team and one small revenue team and assume that their winning percentages sum to 1.00)

MR_L = 100 – 120 W_L

MR_S = 60 – 80 W_S

Solve for both winning percents and the MR in equilibrium. Show this on your graph.

Answer 1

AS MR falls with increases in wins percents, it is only at point E that talent will cease to be hired and hence become an equilibrium because both teams are prepared to pay the same price for talent. Any increase in Team 1's win percent must be met by Team 2's win percent. The larger team produces more wins than the smaller team. In the graph below, it is clear that the marginal revenue from hiring talent is equal across large and small-revenue markets in equilibrium.  The equal marginal revenue outcome is where MR_L* = MR_S*. Revenue imbalance is shown by the fact that there is a large-revenue market and a small-revenue market team in the first place. Every level of quality chosen is more valuable at the margin to the larger-revenue market team. The result in equilibrium is competitive imbalance since W_L* > W_S*. Payroll for the large-market team is larger than for the small-market team.