Monopsony
In economics, a monopsony is a market structure in which a single buyer substantially controls the market as the major purchaser of goods and services offered by many would-be sellers. The microeconomic theory of monopsony assumes a single entity to have market power over all sellers as the only purchaser of a good or service. This is a similar power to that of a monopolist, which can influence the price for its buyers in a monopoly, where multiple buyers have only one seller of a good or service available to purchase from.
Etymology
The term "monopsony" "single" and ὀψωνεῖν was first introduced by the British economist Joan Robinson in her influential book, The Economics of Imperfect Competition. Robinson credited classics scholar Bertrand Hallward of the University of Cambridge with coining the term.History
Monopsony theory was developed by economist Joan Robinson in her book The Economics of Imperfect Competition. Economists use the term "monopsony power" in a manner similar to "monopoly power", as a shorthand reference for a scenario in which there is one dominant power in the buying relationship, so that power is able to set prices to maximize profits not subject to competitive constraints. Monopsony power exists when one buyer faces little competition from other buyers for that labour or good, so they are able to set wages or prices for the labour or goods they are buying at a level lower than would be the case in a competitive market. In economic literature the term "monopsony" is predominantly used when referring to labour markets; however, it could be applied to any industry, good or service where a buyer has market power over all sellers.A classic theoretical example is a mining town, where the company that owns the mine is able to set wages low since they face no competition from other employers in hiring workers, because they are the only employer in the town, and geographic isolation or obstacles prevent workers from seeking employment in other locations. Other more current examples may include school districts where teachers have little mobility across districts. In such cases the district faces little competition from other schools in hiring teachers, giving the district increased power when negotiating employment terms. Alternative terms are oligopsony or monopsonistic competition.
Static monopsony in a labour market
The standard textbook monopsony model of a labour market is a static partial equilibrium model with just one employer who pays the same wage to all the workers. The employer faces an upward-sloping labour supply curve, represented by the S blue curve in the diagram on the right. This curve relates the wage paid,, to the level of employment,, and is denoted as an increasing function. Total labour costs are given by. The firm has total revenue, which increases with. The firm wants to choose to maximize profit,, which is given by:At the maximum profit, so the first-order condition for maximization is
where is the derivative of the function implying
The left-hand side of this expression,, is the marginal revenue product of labour and is represented by the red MRP curve in the diagram. The right-hand side is the marginal cost of labour and is represented by the green MC curve in the diagram. Notably, the marginal cost is higher than the wage paid to the new worker by the amount.
This is because, by assumption, the firm has to increase the wage paid to all the workers it already employs whenever it hires an extra worker. In the diagram, this leads to an MC curve that is above the labour supply curve S.
The first-order condition for maximum profit is then satisfied at point A of the diagram, where the MC and MRP curves intersect. This determines the profit-maximizing employment as L on the horizontal axis. The corresponding wage w is then obtained from the supply curve, through point M.
The monopsonistic equilibrium at M can be contrasted with the equilibrium that would obtain under competitive conditions. Suppose a competitive employer entered the market and offered a wage higher than that at M. Then every employee of the first employer would choose instead to work for the competitor. 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 profit arising from additional employees who decided to work in the market because of the wage increase. But the first employer would respond by offering an even higher wage, poaching the new rival's employees, and so forth. As a result, a group of perfectly competitive firms would be forced, through competition, to intersection C rather than M. Just as a monopoly is thwarted by the competition to win sales, minimizing prices and maximizing output, competition for employees between the employers in this case would maximize both wages and employment.
Welfare implications
The lower employment and wages caused by monopsony power have two distinct effects on the economic welfare of the people involved. Firstly, it redistributes welfare away from workers and to their employer. Secondly, it reduces the aggregate welfare enjoyed by both groups taken together, as the employers' net gain is smaller than the loss inflicted on workers.The diagram on the right illustrates both effects, using the standard approach based on the notion of economic surplus. According to this notion, the workers' economic surplus is given by the area between the S curve and the horizontal line corresponding to the wage, up to the employment level. Similarly, the employers' surplus is the area between the horizontal line corresponding to the wage and the MRP curve, up to the employment level. The social surplus is then the sum of these two areas.
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 under monopsony. By contrast, the yellow triangle is the part of the competitive social surplus that has been lost by both parties, as a result of the monopsonistic restriction of employment. This is a net social loss and is called deadweight loss. It is a measure of the market failure caused by monopsony power, through a wasteful misallocation of resources.
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 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. Thus the rate of exploitation is zero under competitive conditions, when this elasticity tends to infinity. Empirical estimates of by various means are a common feature of the applied literature devoted to the measurement of observed monopsony power.
Finally, it is important to notice that, while the gray-area redistribution effect could be reversed by fiscal policy, 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 directly by law or through collective bargaining laws requiring union membership. While it is generally agreed that minimum wage price floors reduce employment, economic literature has yet to form a consensus regarding the effects in the presence of monopsony power. Some studies have shown that if monopsony power is present within a labour market the effect is reversed and a minimum wage could increase employment.This effect is demonstrated in the diagram on the right.
Here the minimum wage is
This condition is still inefficient compared to a competitive market. The line segment represented by A—B shows that there are still workers who would like to find a job, but cannot due to the monopsonistic nature of this industry. This would represent the unemployment rate for this industry. This illustrates that there will be deadweight loss in a monopsonistic labour environment regardless of minimum wage levels, however a minimum wage law can increase total employment within the industry.
More generally, a binding minimum wage modifies the form of the supply curve faced by the firm, which becomes:
where is the original supply curve and 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 according to the value taken by the minimum wage, as shown by the following table:
| Minimum wage | Resulting equilibrium | |
| First Case | < monopsony wage | where the monopsony wage intersects the supply curve |
| Second Case | > monopsony wage but ≤ competitive wage | at the intersection of the minimum wage and the supply curve |
| Third Case | > competitive wage | at intersection where minimum wage equals MRP |
Yet, even when it is sub-optimal, a minimum wage higher than the monopsonistic rate can raises the level of employment anyway. This is a highly remarkable result because it only follows under monopsony. Indeed, under competitive conditions any minimum wage higher than the market rate would actually reduce'' employment, according to classical economic models and the consensus of peer-reviewed work. 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. This technique was used, for example in a series of studies looking at the American labour market that found monopsonies existed only in several specialized fields such as professional sports and college professors.