Monopsony

In economics, a monopsony is a market with only one buyer in the market, often an input market. This is analogous to the case of a monopoly in which there is only one seller in a market.

During the era of the robber barons, John D. Rockefeller used his monopsony power to take advantage of the Union Pacific railroad by making a deal that forced the railroad to pay his Standard Oil if they were to ship any oil other than Standard Oil.

Monopsony means that a business with monopoly power can control the supply of the goods that they buy. That means that it can reduce the quantity of an input demanded in order to depress the price of that input. This contrasts with a competitive buyer, which simply buys as many units of input as long as the marginal benefit exceeds the input price, over which it has no control. Monopsony power in essence gives a business the ability to control their unit cost of paying for an input, similar to how a monopoly can control their price.

Sometimes with monopoly power in markets comes monopsony power because as well as selling the most they buy the most. This in turn gives monopsony/monopoly businesses above-normal profits when they (1) reduce input purchases to forcibly lower their unit costs and (2) decrease output supply, raising its price. This raises profits via both ends of the spectrum.

Monopsony in labor markets

The "classic" case of a monopsony in labor markets is the "company town," an isolated town where there is only one employer (or almost everybody is dependent on a single employer for their livelihood). This situation was seen in places in the United States during the 19th century, but most economists see it as rare today in the richer countries. But Alan Manning's 2003 book, Monopsony in Motion: Imperfect Competition in Labor Markets (ISBN 0691113122) suggests that this kind of market is common if not ubiquitous in labor markets. Workers face limited mobility between jobs and limited information about available jobs, so that their employers monopsonistic advantage. Further, the monopsony power of an employer is increased when there is significant unemployment since that raises the cost of quitting one's job and lowers the probability of finding a new one.

In the case of a monopsonistic employer of labor, the imposition of a minimum wage can actually raise employment, as seen below.

Graphical analysis

A monopsonistic employer maximizes profits at point M, a competitive one at point C. The monopsonist's limiting of employment depresses wages.

The behavior of a simple monopsonistic employer of labor compared to that of a competitive employer in the diagram. It is assumed, for simplicity, that the company also has a monopoly in the product market.

Following neoclassical economics, hiring decisions are made following marginal analysis: labor as hired as long as the extra benefit of hiring exceeds the extra cost of doing so. Thus, profit maximization implies that the marginal benefit of hiring labor equals the marginal cost of doing so (the MCL).

In neoclassical economics, when the product market is competitive, the marginal benefit of hiring equals the value of the marginal product of labor (VMP). It corresponds to the demand-for-labor curve in the diagram. However, if the company has a product-market monopoly, there is an incentive to restrict output — and thus employment — in order to keep the product price up. Thus the benefits of hiring equal the marginal revenue product of labor, i.e.,

MRP = Δtotal revenue/ΔL

The MRP line is closely related to the marginal revenue (MR) line in a graph for a monopoly firm. For a firm without monopsony power, the marginal cost of hiring labor (MCL) is simply equal to the wage rate (W) because the employer's decisions have no obvious effect on wages. This corresponds to points along the supply-of-labor curve. Thus, the employment decision sets

MRP = W to maximize profits.

In the graph, equilibrium is represented by point C. The wage is thus W_C and employment is L_C. (If the firm does not have monopoly power in its product market, the MRP line would correspond to the demand-for-labor curve. In that case, hiring would be determined by the point where the supply and demand curves intersect, at an even higher level of employment.)

In general, the marginal cost of hiring labor is defined as the rise in total labor costs divided by the rise in labor:

MCL = Δ(W*L)/ΔL

In the case of the monopsonist, this is not simply the wage but also any increase in wages that occurs due to increased employment. So the MCL exceeds the wage at any given level of employment (except zero), as shown in the diagram. Then, for a firm that is competitive in the product market,

MRP = MCL to maximize profits.

Profit maximization occurs at point M. This determines the point on the supply-of-labor curve that the employer chooses. Thus, the wage is W_M and employment is L_M. Both wages and employment are lower than in the competitive case. (If the company lacks monopoly power in its product market, then hiring would be determined by the point where the supply and demand curves intersect, at a higher level of employment.)

If a minimum wage is established and successfully enforced, that implies that the firm sees a horizontal labor supply curve to the left of the normal competitive supply curve, as with the solid red line drawn between W_M and W_C at a wage equal to min. (A similar result can occur due to the actions of a labor union.) For this horizontal segment, the MCL equals the wage rate since the firm's employment decisions have no effect on the wage. If the minimum wages is higher than W_M and lower than or equal to W_C, then the imposition of the minimum wage implies that employment rises relative to the monopsonistic situation. On the other hand, if the minimum wage rises above W_C, that decreases employment relative to L_C. It is possible, however, that employment could still be above L_M, as long as the minimum wage is below the wage W* corresponding to point M.

See also: labor economics

Non-labor examples

• An example of a market with a monopsony is the market for road construction, in which there are many suppliers but only one significant buyer (the government).
• The arms industry is another example when the only (domestic) customer is the state.
• Single-payer healthcare is a system where the government is the only buyer.

These examples indicate that the government can have monopsony power. The first two also suggest that in the real world, we cannot ignore the existence of what John Kenneth Galbraith termed "countervailing power." The construction industries are often well organized and can form a coalition with government decision-makers to dedicate too many resources to road construction, rather than the too few that are suggested by the simple monopsony model. Similarly, it is often alleged that the military-industrial complex involves a coalition that dedicates too many resources to military purposes. Well organized medical professions and pharmaceutical industry could produce similar results with single-payer healthcare.

See also

• Market forms
• Minimum wage
• Oligopsony