A business situation where there is only one buyer - a buyer's monopoly. It is very rare on any significant scale.
In economics, a monopsony is a market form with only one buyer, called "monopsonist," facing many sellers. The term "monopsony power", in a manner similar to "monopoly power" is used by economists as a short hand reference to buyers who face an upwardly sloping supply curve but that are not the only buyer;
Overview
A monopsonist has market power, due to the fact that he/she can affect the market price of the purchased good by varying the quantity bought.
For most practical purposes, what matters is monopsony power as such, whether it is exercised by one or more subjects. In standard microeconomics, where monopsonists or oligopsonists are assumed to be profit-maximizing firms, monopsony power leads to a market failure, due to a restriction of the quantity purchased relative to the (Pareto-) optimal competitive outcome.
Traditional microeconomics tended to assume that in most modern cases such intensity was small enough to be ignored, justifying as an acceptable approximation the general use of much simpler competitive models.
This view has however been variously questioned by the more recent literature devoted to the actual measurement of monopsony power in observed markets.
Reasoning a priori, the specific dynamics of labour markets – and particularly search behaviour by workers – may indeed formally produce upward-sloping labour supply curves faced by most individual firms in the short run: see Mortensen (1970).
A wide and useful survey of both the theoretical and empirical literature on monopsony in labour markets may be found in Boal and Ransom (1997).
Static monopsony in a labour market
The standard textbook monopsony model refers to static partial equilibrium in a labour market with just one employer who pays the same wage to all its workers.
This leads to the first-order condition:
.The left-hand side of this expression is the marginal revenue product of labour (roughly, the extra revenue produced by an extra worker) and is represented by the red MRP curve in the diagram. It should be noticed that this marginal cost is higher than the wage w(L) paid to the new worker by the amount
.This is due to the fact that the firm has to increase the wage paid to all the workers it already employs whenever it hires an extra worker.
The first-order condition for maximum profit is then satisfied at point A of the diagram, where the MC and MRP curves intersect.
The monopsonistic equilibrium at M should now be contrasted with the equilibrium that would obtain under competitive conditions. Moreover, the competitor would gain all the former profits of the first employer, minus a less-than-offsetting amount from the wage increase of the first employer's employees, plus profits arising from additional employees who decided to work in the market because of the wage increase.
Welfare implications
The lower employment and wage caused by monopsony power has two distinct effects on the economic welfare of the people involved.
The diagram on the right illustrates both effects, using the standard approach based on the notion of economic surplus.
Following such definitions, the grey rectangle in the diagram is the part of the competitive social surplus that has been redistributed from the workers to their employer(s) under monopsony.
As the diagram suggests, the size of both effects increases with the difference between the marginal revenue product MRP and the market wage determined on the supply curve S. This difference corresponds to the vertical side of the yellow triangle, and can be expressed as a proportion of the market wage, according to the formula:
.The ratio e has been called the rate of exploitation, and it can be easily shown that it equals the reciprocal of the elasticity of the labour supply curve faced by the firm.
Finally, it is important to notice that, while the grey-area redistribution effect could be reversed by fiscal policy (i.e., taxing employers and transferring the tax revenue to the workers), this is not so for the yellow-area deadweight loss. The market failure can only be addressed in one of two ways: either by breaking up the monopsony through anti-trust intervention, or by regulating the wage policy of firms. The most common kind of regulation is a binding minimum wage higher than the monopsonistic wage.
Minimum wage
A binding minimum wage can be introduced either by law or through collective bargaining, and its possible effects in a special case are shown in the diagram on the right.
Here the minimum wage is w'', higher than the monopsonistic w. At this given wage the firm can now hire all the workers it wants, up to the supply curve, so that in the relevant employment range its marginal cost of labour becomes effectively constant and equal to w'', as shown by the new black horizontal line MC'.
More generally, a binding minimum wage modifies the form of the supply curve faced by the firm, which becomes:
where w(L) is the original supply curve and wmin is the minimum wage. The new curve has thus a horizontal first branch and a kink at the point
as is shown in the diagram by the kinked black curve MC' S. The resulting equilibria can then fall into one of three classes or regimes, according to the value taken by the minimum wage, as is seen by the following table:
Minimum-wage regimes in monopsonistic labour markets| Minimum wage | Resulting equilibrium | |
|---|---|---|
| First regime | not higher than monopsony wage | unchanged from monopsony |
| Second regime |
higher than monopsony wage but not higher than competitive wage |
at kink of supply curve |
| Third regime | higher than competitive wage | at intersection where minimum wage equals MRP |
As it is now seen, the example illustrated by the diagram belongs to the third regime.
Yet, even when it is sub-optimal, a minimum wage higher than the market rate raises the level of employment anyway. Indeed, under competitive conditions any minimum wage higher than the market rate would actually reduce employment. Thus, spotting the effects on employment of newly introduced minimum wage regulations is among the indirect ways economists use to pin down monopsony power in selected labour markets.
Wage discrimination
Just like a monopolist, a monopsonistic employer may find that its profits are maximised if it discriminates prices. In this case this means paying different wages to different groups of workers even if their MRP is the same, with lower wages paid to the workers who have a lower elasticity of supply of their labour to the firm.
Some researchers have tried to use this fact to explain at least part of the observed wage differentials whereby women earn often less than men, even after controlling for observed productivity differentials.
Some authors have argued informally that, while this is so for market supply, the reverse may somehow be true of the supply to individual firms.
Dynamic problems
In many real-world situations a monopsonist firm will have to maximise its profits through time, rather than instantaneously as in the previous static model.
The simplest dynamic model to bring out this idea, used in Boal and Ransom (1997), is one where the supply of labour to the firm reacts to wage changes with a lag, due for instance to information costs and search behaviour. Assume hence that the supply function has a distributed-lag specification, leading to:
,where the subscript refers to the time period and L is increasing in both arguments. Inverting this function gives:
,with
.If the firm has a time-discount rate r, the present value of profits is now given by:
.The tth first-order condition to maximise this present value is:
.Define next the short-run simultaneous and lagged inverse supply elasticities respectively as:
.Finally, the steady-state long-run inverse elasticity, , is given by the sum of the two short-run inverse elasticities defined above, and so one has:
.The exploitation rate is thus a weighted average of the short- and long-run inverse supply elasticities, where the weight of the long-run one is much bigger, because r is much smaller than unity even when the discounting period is one year.
However, less simplified dynamic models tell less simple stories.
Empirical problems
The simplified dynamics sketched above suggests that the frequent observation of short-run relative inelasticity of labour supply to individual firms may not be very relevant to the diagnosis of significant monopsony power. Efforts to measure the size of the exploitation rate in specific labour markets have hence taken various forms:
direct measurement of wage and MRP estimates of the long-run supply elasticity of labour to firms cross-sectional comparisons of wages and employer concentration correlations between wages and workers' mobility structural estimation of equilibrium search models employment effects of minimum wagesThe results of these empirical works are rarely unambiguous.
The sources of labour monopsony power
The simpler explanation of monopsony power in labour markets is barriers to entry on the demand side.
However, monopsony power might also be due to circumstances affecting entry of workers on the supply side, directly reducing the elasticity of labour supply to firms.
An alternative that has been suggested as a source of monopsony power is worker preferences over job characteristics (Bhaskar and To, 1999; If different workers have different preferences, employers have local monopsony power over workers that strongly prefer working for them.
Monopsony in product markets
The same or similar empirical difficulties dog the attempts to identify significant monopsony in non-labour markets, and specifically in markets for intermediate goods bought as inputs by very large firms. jet fighters, tanks, artillery, etc.)
A related issue is the role of monopsony power from the point of view of anti-trust policy affecting vertical integrations.
In Australia, the Pharmaceutical Industry can be viewed as a kind of Monopsony, as the Commonwealth government is the principle buyer of products through the Pharmaceutical Benefits Scheme(PBS)
In the US, a case is made that Wal-Mart is a monopsonist, dictating terms to suppliers, whilst at the same time a monopolist dictating terms to consumers - at least in certain market segments .
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