This paper provides a theoretical model of a team sports league and studies the welfare effect of salary caps. It shows that salary caps will increase competitive balance and decrease overall salary payments within the league. The resulting effect on social welfare is counter-intuitive and depends on the preference of fans for aggregate talent and for competitive balance. A salary cap that binds only for large-market clubs will increase social welfare if fans prefer aggregate talent despite the fact that the salary cap will result in lower aggregate talent. If fans prefer competitive balance, on the other hand, any binding salary cap will reduce social welfare.
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