We expect the owner of a major league baseball (MLB) team to choose the quantity (the number

Question:

We expect the owner of a major league baseball (MLB) team to choose the quantity (the number of fans at the game) at which marginal revenue equals marginal cost (MR = MC). The marginal cost of an additional fan is close to zero, so the profitmaximization rule simplifies to MR = 0. And yet for the typical team, it appears that MR is actually negative: adding fans by selling more tickets actually decreases total revenue from tickets. What explains this puzzling behavior?

We can illustrate the puzzle with a simple example. Suppose that with a ticket price of $24, the team sells 20,000 tickets. If the slope of the demand curve is -0.002, marginal revenue is - $16:

MR = $24 - 0.002 * 20,000 = -16

In this case, cutting the price to sell one more ticket generates good news ($24 collected from the new fan) that is less than the bad news (the $40 lost on the 20,000 fans who would have paid the higher price). The marginal revenue is negative, so the team could increase its total revenue from tickets by increasing the price and decreasing the quantity of tickets sold. Why don’t MLB teams increase their ticket prices?

The solution to this puzzle is concessions. Suppose the average MLB fan spends $20 per game on merchandise that costs the owner about $4 to provide. In this case, each ticket sold generates an additional $16 in net concession revenue to the owner, just enough to offset the $16 revenue loss on ticket sales. Once we expand the definition of marginal revenue to include the net revenue from concessions, the owner’s choice is consistent with profit maximization. What appears to be too low a price could be just about right.