Have you read my post about How Much Does Each Team Invest on Baseball? I have a lot of opinions about how profitable winning is. I would not go through them again now for the purposes of redundancy, but the basic inference is that winning produces substantial profits through incremental ticket purchases, additional product sales, reductions in job burden (selling purchase costs), rises in ticket values, enhanced audience interest, intangibles, etc. So how can these teams determine just how much they can invest on a free agent that is pending? Ok, in a rational manner, you should really think about this. It’s more readily achieved with simplistic examples, as with something, so stick with me as we establish a central stage.
Economics 101: Saving on your savings where your returns meet (Accounting For Risk)
In your entry-level economics class, you can also discover that in a perfectly dynamic setting, the price is fixed when supply matches demand. You can often discover that it is expected in their explanations that people will compete to the extent where their marginal gain matches their marginal expenses. If these concepts are new to you, here’s a short example:
Say, you’re in a city and you’re a banana vendor, and you’re the only one. Assume that in order to do so, there is a fixed expense to market these bananas (say, a selling permit that you bought one time that you cannot resell). Assume therefore for any banana you offer often has a variable cost – the cost of the banana itself, as well as the cost of your time, etc. This is solely based on how much you offer. There is a small advantage, on the other side, that you reap by selling each banana – say in the money you get in the deal. Simple economics states that as long as your marginal gain is greater than your marginal expense, you can manage to sell bananas. That is, if you wanted to decide that you would sell your bananas for $4 and it would cost you $3 a banana at a marginal cost, you would sell it.
If you could just sell your bananas for say, $3.01, because there will always be a marginal profit along with your marginal expense, you would want to sell. Theoretically, the concept of your next best options (say, you might make a bigger profit selling apples) could also take marginal costs into account (as a note). Hardcore economics would also inform you that because marginal profit meets marginal expense, sellers would sell (you can still sell if you were just selling them for $3. I believe this is just for the sake of convenience, but the argument is still unimportant.)
Here, the fixed sunken expense is a significant note: it is neglected. That’s how it falls under the “sunk cost” bucket, one that will not be retrieved no matter what and should not be taken into consideration. Now, of course, there are very few cases of legitimate products in the modern world that can’t be offered on the open market, so there’s a football stadium out there, as far as things go. We would assume that selling the stadium itself and taking the cash and investing in anything new will be quite challenging – there are incredibly strong exit hurdles to such a challenge and the stadium is rarely operated by a single person. Therefore, as we consider in economic terms here, we can presume that the stadium itself is a sunken price that should not be taken into account.
Besides that, the overall conclusion I want you to come to here is that teams can ideally invest just like bananas to the point where, according to economic theory, their marginal expense matches their marginal gain.