Monopsony

What is Monopsony?

Monopsony consists of a market condition that is heavily influenced by a single buyer. It is the opposite of a monopoly – a market condition with only one seller. In monopsonies, the buyer exerts a majority of control over the purchase of a good or a service, which gives them higher power during negotiations.

Understanding Monopsonies

Monopsonies are common in the labor market in situations where only one company is responsible for supplying a lot of jobs. Labor market monopsonies tend to be disadvantageous for workers since companies can negotiate for lower wages due to their power in the market.

The diagram below illustrates a monopsonistic labor market, where only one company (the buyer) faces many workers looking for jobs (the sellers).

As shown in the diagram, the marginal cost of labor increases with the quantity of labor hired. The marginal cost curve assumes a steeper slope than the labor supply curve due to the fact that increasing wages for each additional worker implies increasing the wages for all workers, so the cost increases faster than the quantity of labor employed.

At the same time, the marginal revenue generated by each additional worker (which also forms the demand curve) falls, in accordance with the law of diminishing marginal returns.

In such a case, the optimal quantity of labor for the supplier is Ql*, which is the quantity at which the marginal cost of labor equals the marginal revenue generated by it. At such quantity, the ideal wage would be w*, and there would be no deadweight loss.

However, due to the presence of a monopsonist with market power, the wages are driven down to W_m, which is the market wage determined by the supply curve.

Monopsony and Minimum Wages

Although the introduction of minimum wages is commonly associated with a decrease in the quantity of labor demanded, the effect of minimum wages in monopsonies is quite the opposite.

In the earlier diagram, the monopsonist would need to increase the wages of everyone for each additional unit of labor hired. With a floor on the wage, the marginal cost of labor remains constant (since each additional unit is paid the constant minimum wage rather than a higher amount), and the quantity of labor hired increases. It is shown in the diagram below:

With the minimum wage fixed at w*, the marginal cost of labor is constant with the supply curve at w* until it intersects with the downward sloping marginal revenue curve (or demand curve). Therefore, the marginal cost of each additional unit of labor employed is constant until that point, and employers are incentivized to hire until MR = MC.

The optimal quantity is Ql*, which is higher than the quantity of labor employed before the minimum wage legislation (highlighted as Ql1). Despite the increase in wages, the quantity of labor employed increases since the monopsonist benefits from constant marginal costs.

Advantages of Monopsony

• Being a monopsonist in the labor market allows companies to achieve economies of scale and lower long-run average costs. It increases profits and returns to stakeholders.

• For monopsonists that invest in R&D, capital investment, and/or charitable causes, it helps the rich give back to society.

Disadvantages of Monopsony

• Suppliers are squeezed to settle at lower prices due to restrictions on alternatives.
• Specific to the labor market, lower wages may sometimes mean that wages fall below the productivity of workers. It may slow down the growth of the economy and have detrimental effects on educational attainment.

Examples of Monopsonies in Different Markets

Supermarkets

Food retailers exercise power when buying supplies from farmers and milk producers. For example, British Sugar buys almost the entire sugar beet crop produced in the U.K. each year. On the other hand, consumers benefit from lower prices in grocery stores.

Labor

A labor market monopsony enables the employer to set low wages and heavily influence the number of employees working.

The government is a monopsonist in the employment of civil servants, military, police, and naval officers. Even though placing a minimum wage can increase wages without increasing unemployment, it is difficult to fight for the same in industries that are governed by the institutions themselves.

Consumer Products

Amazon is known for its buying power in the retail book market. Famous American economist Paul Krugman mentioned in October 2014 that by pushing down publisher prices, Amazon is hurting readers, too.

The U.K.’s NHS is a major large purchaser of prescription drugs; however, the reduced prices can be facilitated into cheaper treatments for the public as part of the budget.

Related Readings

CFI offers the Commercial Banking & Credit Analyst (CBCA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following resources will be helpful:

Aggregate Supply and Demand

Economic System

Monopolistic Markets

Supplier Power

• See all economics resources