Five months ago, I laid out the beginnings of an explanation for price rigidity, based on the concept of imperfect competition. One of these days, I’ll think through the idea a bit more, build a model, and see if there’s actually anything there. For the time being, some superficial evidence will have to do.

My theory posits a situation where an uneven distribution of the demand shortage can change the distribution of market power, under the assumption of product differentiation,

Suppose an industry with n firms is impacted by a fall in demand, caused by a rise in the demand for money. To make the model clearer, let’s take it to the extreme and assume that only one firm suffers the demand shortfall, such that n–1 firms can continue to sell the same quantity of output at the same price. Further, suppose that the distribution of inputs to firms is symmetric, implying that the higher the value of n is, the less the one firm can influence the price of inputs (i.e. if all firms reduce their demand for inputs, the price of inputs will fall). The result is that the one firm has to reduce its output, and the inputs that otherwise would have been purchased are now idle.

Or, assume an uneven distribution of market power (still an imperfectly monopolistic market). Further, suppose there is a recession and a subsequent demand shortage. My theory is that firms with greater market power — who are in a better position to weather the decline in receipts — can keep input prices relatively high, where firms less able to survive the recession are forced to pay input prices above what would be the case in a perfectly competitive market.

Do European football markets offer some evidence for this theory? Consider Spain’s La Liga, where you have two clubs who are dominating European football (Real Madrid and Barcelona) and 18 which are struggling domestically. Despite the generally poor financial state of Spanish football, Real Madrid and Barcelona can essentially buy whatever players they want at higher prices than any competitor (e.g. €57 million for Neymar; €91 million for Bale; €94 million for Cristiano Ronaldo; €35 for Illarramendi; €30 million for Isco; …the list goes on and on). Together with other European clubs with relatively high market power, such as Bayern Munich, Manchester United, Paris Saint Germain, Chelsea, Manchester City, et cetera, they raise the price of quality players. They raise the price level, so to speak.

Let’s generalize and say that a club’s value marginal product is a function of the quality of its players. The other 18 Spanish football teams, who are struggling financially because they are affected more by the demand shortage than R.M. and Barça, now face a higher price level than what would be the case if market power were more evenly distributed. This makes buying quality players very difficult. With reduced incomes, they can’t afford these players at existing prices. They opt for lower quality substitutes (although, youth academies can also occasionally produce youths of high quality), and the average quality of input falls. This is the same thing as saying that their output, and therefore real income, declines.

Clubs with typically tight budget constraints typically turn to youths (~18–22 years old). A club with a mean quality that allows it to place somewhere within the top 10 by the end of the season might have 1–3 truly high quality youths (with the average probably closer to 1). If they have a high debt burden, with falling real incomes, they can earn a good return by selling their youths to clubs of high market power. Real Sociedad sold Illarramendi for €35 million to Real Madrid; Málaga sold Isco to Real Madrid for €30 million; Sevilla sold Geoffrey Kondogbia for €20 million; Atlético Madrid has had to raise the buy-out clauses for their youth players, in case they can’t match their wealthy competitors’ wage offers. The result is that clubs find it difficult to retain the talent they produce at home. In other words, clubs with higher market power can offer their less well off, debt-constrained competitors a price that compensates them for foregoing the opportunity to use (and develop) their youths and sell them at a future date.

Generalizing, the process of buying youth-academy products from debt-constrained clubs is analogous to high market power firms buying their low market power rivals’ best inputs. Say that an input produces a continuous stream of output over some period of time. In this case, firms with high market power can pay a current price that makes it worthwhile for debt-constrained clubs to forgo the alternative of earning the continuous flow of revenue. They also have to compensate the seller for forgoing the expected future value of the player. This type of horizontal exchange of inputs is probably not relevant for most goods, but it does seem relevant for the one good that we typically think of suffering from price rigidity: labor.

But, an unequal distribution of market power can apply to many industries, and this may mean that these markets are prone to price levels that force smaller firms to cut output, because they can no longer afford to buy as many inputs (or they have to substitute with lower quality inputs).