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Perfectly Competitive Superstars

Why do they make so much money? A theory of similar skills but very different paychecks.

September 1, 2002


Perfectly Competitive Superstars

Is Texas Rangers shortstop Alex Rodriguez worth $25.2 million a year? How about NBC news personality Katie Couric: Does she deserve her $13 million to $15 million salary, perhaps three times what veteran journalist Mike Wallace makes? And why did the members of Aerosmith have to split a paltry $25 million last year while U2's crew shared earnings of $69 million?

Mere economists will probably never fully fathom such profound mysteries, but it's not because huge celebrity salaries have escaped their attention. The question of why superstars are paid so much more than the average person in their field—far more, indeed, than their close competitors—was the focus of a 1981 paper "The Economics of Superstars" by University of Chicago economist Sherwin Rosen.

About numerous professions—from comedians to economists to classical musicians—Rosen made two key observations. First, "performers of the first rank ... have very large incomes." Second, there are "substantial differences in income between them and those in the second rank, even though most consumers would have difficulty detecting more than minor differences. ..." Standard economic theory provides no explanation for these observations, he noted. "Competitive theory is virtually silent about any special role played by either the size of the total market or the amount of it controlled by any single person" because products are assumed to be virtually identical.

But Rosen provided a careful and complex explanation focusing on two things: imperfect substitution among different sellers and scale economies of joint consumption technologies. The first simply means that lesser talent is a poor substitute for greater talent. "Hearing a succession of mediocre singers does not add up to a single outstanding performance," wrote Rosen.

The second notion is that certain technologies allow very few sellers to service the entire market. Before the advent of the phonograph, your town's local singing star might be the best you'd ever hear; with Edison's invention, the voice of Enrico Caruso could spread across the globe.

"When the joint consumption technology and imperfect substitution features of preferences are combined," Rosen observed, "the possibility for talented persons to command both very large markets and very large incomes is apparent."

Does competitive innovation diminish superstars?

Twenty years later, Boldrin and Levine pick up where Rosen left off. In a short section of "Perfectly Competitive Innovation," they apply their theory of innovation to the phenomenon of superstars. One might suspect that superstar salaries have something to do with monopoly power, they observe, but that needn't be the case. Superstars will emerge even under perfect competition because of the impact of reproduction technology on prices paid to laborers of varying quality.

"Our model predicts that superstars should abound in industries where the main product is information which can be cheaply reproduced and distributed on a massive scale," wrote Boldrin and Levine. "Such is the case for the worlds of sport, entertainment, arts and letters, which coincides with the penetrating observations that motivated Rosen's original contribution." (They note that their idea is just one of a number of possible explanations for the super-salary phenomenon, but they suggest it is simpler, more elegant and more realistic than other theories that have been offered.)

Their model shows that, if there are indivisibilities, technological changes in reproduction that lower prices and broaden markets will initially be beneficial to all entertainers. Real wages will increase at a uniform rate for all types of labor. "Eventually, though, further improvements in the reproduction technology lead to a 'crowding out' of the least efficient ...," they wrote. As reproductive capacity increases still further, the superstar will capture the entire market and gain disproportionately high wages.

Thus, even very small differences in skill are magnified by technology that copies and distributes information with increasing ease. "Our theory," concluded Boldrin and Levine, "predicts that the increased reproducibility of information will continue generating large income disparities among individuals of very similar skills and in a growing number of industries."

The irony, of course, is that rapid innovation in information technology—championed by the underdogs at Napster and elsewhere—may result in an expanded galaxy of superstars and a growing gap between their salaries and ours.