Monday, June 30, 2008
Economics of trading: Price elasticity of demandPosted by Derek Carty at 8:18pm
A couple of weeks ago, we looked at why it makes sense to buy players early and sell players late using the economic concept of supply and demand. Today, I'd like to bring another economic concept into the discussion: price elasticity of demand. If you didn't read the last article, I'd definitely recommend you do so before continuing.
What is price elasticity of demand?
In our last discussion of the economics of trading, we talked about how the various determinants of demand change the prices of players throughout the season. What we didn't discuss was how receptive owners are to changes in price. This is where price elasticity of demand comes into play.
Price elasticity of demand tells us how responsive consumers are to changes in the price of a particular good.
If you're looking to buy a can of Coca Cola and you see that the Coke Corporation has bumped the price up by $10 per can, you are probably not going to buy that Coke. Maybe you'll buy a Pepsi, or maybe you'll forgo soda all together. When changes in price significantly affect your decision to purchase the product, your demand for the product is said to be elastic.
On the other hand, if the water company bumps up the cost of your home's water, you might be upset, but you are still going to buy the water. In this case, your demand is said to be inelastic since the change in price has relatively little affect on your decision to continue purchasing the water.
Here are the three primary things that affect the price elasticity of demand for a particular good:
- Availability of substitutes
- Time to find substitutes
- Proportion of the consumer’s budget spent on the good
Let's examine each in the context of the fantasy baseball trading market and see if there are any advantages to be gained.
Availability of substitutes
This may seem obvious, but the more substitutes for a particular good are available, the less willing consumers will be to pay a higher price for said good.
Number of substitutes
Let's take a player slightly above replacement level as an example. Right now, in a traditional 12-team mixed league, that might be a player like Scott Rolen (if you don't feel Rolen is replacement level, please replace his name with that of someone who you feel is). If Rolen's owner asks for Eric Chavez in return, it would conceivably be considered, at the very least. If Rolen's owner asks for Garrett Atkins, however, Atkins's owner would likely laugh in his face.
This is because a player like Scott Rolen isn't in any way scarce. Since he is (depending on your opinion of him) roughly replacement level, you could pick up a very similar player off the waiver wire for very little. You would be willing to trade another replacement level player for Rolen, but not much else.
Let's say, however, you feel as though you absolutely need to acquire a base stealer in order to compete in your league. Base-stealers, unlike replacement level players, are scarce. There are only a handful of players that will be able to steal 30 bases the rest of the way. Guys like Jose Reyes, Ichiro Suzuki, Jacoby Ellsbury, and maybe a few more are good bets, but that's about it. If you're looking for an absolutely elite base stealer, your options are limited.
Therefore, if you feel as though you have to have this player, you will be less likely to call off the deal if the price for one of these base stealers increases from Felix Hernandez to Brandon Webb. Your demand for an elite base stealer is very inelastic, so increases in price have less of an influence on your decision to make the trade than it would if you were trying to acquire, say, Scott Rolen.
Definition of substitute
The broader you make your definition of substitute, though, the more elastic your demand becomes. Instead of saying that you want a guy who can steal 30 bases and expand your definition of base stealer to 15 bases, guys like Kaz Matsui, Brian Roberts, Shane Victorino, and a whole bunch more are added to your list of potential targets. So if Ichiro's owner starts asking for Webb, you will have a much easier time telling him 'no' since you have a lot of other players you could target and try to acquire for less.
Strength of substitute
The strength of the substitute is also important. If your definition of base stealer is 15+ steals, this includes both Kaz Mastui and Ichiro. If, however, you can acquire Kaz for Joe Mauer or Ichiro for Russell Martin, while you'd be paying more for Ichiro (replace them with different players if you don't feel Martin is better than Mauer), this is the deal you'll probably take. While you consider Kaz and Ichiro substitutes, they aren't exactly strong substitutes, and the price of each is comparable.
If you get offered Ichiro for Martin or Carl Crawford for Ivan Rodriguez, though, you will probably trade for Crawford because he and Ichiro are very strong substitutes while Martin is substantially better than Ivan. The stronger the substitute, the more elastic the demand.
Time to find substitutes
Last week, we discussed several benefits of trading early. Another benefit is that you are unhindered by time constraints. Let's say you feel like you need to acquire a star pitcher in order to win your league. If you try to trade for the pitcher now, it will simply be a matter of working out what players you are willing to give up and finding another owner that is willing to trade a pitcher for your package.
Say you want to make the trade now, and you'd like to trade Carl Crawford. You first go to Johan Santana's owner. He says no, so you go to Jake Peavy's owner. He says no, so you go to Brandon Webb's owner. He says no, so you go to Josh Beckett's owner, who agrees to the deal. Easy enough.
Let's imagine, however, that you waited, and now it's the day of the trading deadline. You start talking with Johan Santana's owner, who tells you no. You then rush to Peavy's owner, who also says no. You then go to Webb's owner, who says that he would need Jose Reyes to make the deal work.
Had you traded earlier, you would have been able to get a starting pitcher (like Beckett) cheaper or could have gotten a pitcher like Santana or Peavy for Reyes. There would have been more time to negotiate, and you wouldn't be dealing from a position of desperation.
Instead, it's now minutes until the deadline, and you are forced to either go without making a trade or overpay a little bit for the player you need. Because there is no alternative for you — solely because of time constraints — the likelihood of you making the trade greatly increases. If the alternative is not acquiring the player you feel you need to win the league, you're going to make the trade.
Proportion of the consumer’s budget spent on the good
When the price of a good takes up a large portion of the consumer's budget, even a relatively small percentage increase in the price of the good could prevent some consumers from buying the product simply because they will not be able to given the increased price. Therefore, the greater the proportion of the consumer's budget, the more elastic the demand for it.
This really isn't as relevant to fantasy baseball as the first two are. I suppose we could think about this in terms of elite players. The price of elite players is generally very high to begin with, so if the price of a particular elite player you're attempting to trade for rises, it will be extremely difficult for you to actually make the trade since you have finite resources to make trades.
Rule of thumb
A good rule of thumb is the higher the quality of the good in question, the more inelastic the demand.
This makes sense because quality (or perceived quality, at least) comes from a higher price, and a higher price comes from scarcity (think of our last article when we reduced supply — price rises). When a type of player is scarce, he will have few substitutes and therefore, the demand will be inelastic.
Capitalizing on price elasticity of demand
The best way to capitalize on the economic concepts we've discussed thus far is simply to analyze your league, its unique trading market, the various teams in your league, your team, and each trade situation you find yourself in.
Analyze what your league's trade market looks like right now and what it will look like in the future using the determinants of supply and demand we talked about last time. Then, each time you start discussing a trade, take note of the players involved, the players likely leaving your team, and how they would help your opponent. Use the concepts we discussed today to decipher how responsive your opponent would be if you upped your price. Would it be a deal breaker, or would he be compelled to give some more?
Understanding the situations in which you can extract more (and those you can't) will be very helpful in becoming a successful trader. If you do decide to up your price based on these principles, it will become an even higher percentage play if you know your opponent well (a subject we've talked about in-depth before). The more information we have to base our decisions on, the sounder those decisions will be.
Subjectivity and knowing your opponent
Keep in mind that a lot of these concepts are subjective, so it can be very important to know how your opponent thinks. For example, lower tier closers will have more value at the trade deadline than lower tier starting pitchers because there are far fewer closers available. This will be the case in any league. When trying to trade for a lower tier closer, however, the price tag can vary a lot from league to league because of the perception of how close of a substitute a lower tier closer is for an upper tier one.
In a lot of competitive leagues, owners will realize that saves are saves (and save opportunities are mostly a random thing) and that the ERAs and WHIPs of top closers don't provide all that much additional value to the lower tier closers (holding job security constant). In these leagues, the price tag of Mariano Rivera (1.86 LIPS ERA) and Kevin Gregg (4.91 LIPS ERA) won't be incredibly different. There might be a slight dent in Gregg's value because of the possibility of a trade, but if that weren't a possibility, in these leagues Gregg would go for a somewhat comparable price to Mariano.
Yet in other leagues, where owners don't realize that saves are saves and overvalue a reliever's ERA and WHIP, Rivera and Gregg will have widely different price tags.
This is just one example of why knowing your league and your opponent can be critical. Despite using the same concepts and the same players, the price tag can vary greatly from league-to-league or owner-to-owner and make complete sense in the context of that league/owner.
Final thoughts on capitalizing on these concepts
In addition (giving further credence to my notion that we should do our buying early and selling late), if you find that your team needs to acquire a player for which there are few substitutes, make absolutely certain that you start trying to make your deals now. You're already toeing the line of inelasticity, so don't compound this by waiting until the week or the day of the trade deadline to start negotiations. This is a recipe for disaster, as there is a very good chance (especially in a competitive league) that you'll be giving up far more than you need to for your player.
If the player you want does have a lot of substitutes, don't let yourself be pushed around. If the other owner is asking for too much, move on to the next guy on your list. Don't get too enamored with any one player such that you overpay for him when a comparable guy would come cheaper.
Overall, if you understand the concepts we discussed, you simply need to analyze the situation thoroughly and apply the concepts accordingly. Hopefully they will help you to improve your trade equity.
Derek Carty, 23, has also been published by NBC's Rotoworld, Sports Illustrated, FOX Sports, and USA Today. This season, he'll be contributing to FanDuel and will be linking to all of his work at DerekCarty.com. In his three years competing in expert leagues, he has won 2 titles with 4 top three finishes, including a LABR NL title in 2009, making him the youngest person to ever win a major expert league title. Derek is a proud graduate of the MLB Scouting Bureau's Scout Development Program and is a firm believer in the importance of combining stats and scouting. He welcomes questions via e-mail, Facebook, or Twitter.