Labor Economics 5th Edition by George Borjas

Exercise 4

Major League Baseball players are not eligible for arbitration or free-agency until they have been in the league for several years. During these "restricted" years, a player can only negotiate with his current team. Consider a small-market team that happens to own the rights to last year's Rookie-of-the-Year. This player is currently under contract for $500,000 for the next 3 years. Because his current team is in a small market, the player's marginal revenue product for hishis current team is $6 million per year (now and in the future). When the player becomes eligible for free-agency, he will likely command $10 million per year for 7 years in free-agency from competing large-market teams. In the questions below, assume the player wants to maximize his lifetime earnings.
(a) What is the worst 10-year contract extension from the player's point of view that the player would accept from his current team
(b) What is the best 10-year contract extension from the player's point of view that his current team would offer him
(c) Would you expect this player to sign a contract extension or to play out his contract and enter free-agency three years from now