Everything about Monopsony totally explained
In
economics, a
monopsony (from Ancient Greek
μόνος (monos) "single" +
ὀψωνία (opsōnia) "purchase") is a
market form with only one buyer, called "monopsonist," facing many sellers. It is an instance of
imperfect competition, symmetrical to the case of a
monopoly, in which there's only one
seller facing many buyers. The term "monopsony" was first introduced by
Joan Robinson(External Link
) (1933). 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; better, but more cumbersome terms may be
oligopsony or monopsonistic competition. A monopsonist may be at the same time a monopolist.
Overview
A monopsonist has
market power, because he can affect the market price of the purchased good by varying the quantity bought. Formally, this is so because a monopsonist faces a
supply curve with a
finite (and generally positive) price
elasticity. However, one can find this condition – and hence monopsony power – also in markets with more than one buyer. In all such cases the resulting market form is called an
oligopsony.
For most practical purposes, what matters is monopsony power as such, whether it's 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. Moreover, markets with monopsony power are predicted to react differently to public price regulations. Monopsony power is thus relevant from both the normative and positive points of view. The practical importance of its effects depends however on its actual
intensity, measured by the size of the deviation from competitive outcomes.
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. The only and oft-quoted exception to this principle was assumed to be the labour markets of the nineteenth-century "
company towns", which were isolated mining centres with only one employer (the mining company) for almost everybody.
This view has however been variously questioned by the more recent literature devoted to the actual
measurement of monopsony power in observed markets. On the one hand, econometric exercises on the available data have apparently ruled out significant labour monopsony for the typical West Virginia "
company towns" of the early twentieth century: see Boal (1995). On the other hand, many observations appear to suggest significant monopsony power in various
contemporary labour markets, from baseball players to nurses, college professors and many others. There have also been attempts to measure possible monopsony power in some non-labour markets as well.
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). On the longer-run supply behaviour of dynamic models, however, it's much more difficult to get simple general results on purely theoretical grounds, so that any firm conclusion must come from case-by-case empirical analysis.
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). See also the large bibliography provided at the end of Manning (2003).
Static monopsony in a labor market
The standard textbook monopsony model refers to static partial equilibrium in a labor market with just one employer who pays the same wage to all its workers. In this model, the employer is assumed to be a firm facing an upward-sloping
labor 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 the increasing function
. Total labor costs are then given by
. Assume now that the firm has a total revenue
, which increases with
according to the concave function
. It wants to choose
to maximize profits, which are given by:
» .
This leads to the first-order condition:
» .
The left-hand side of this expression is the
marginal revenue product of labor (roughly, the extra revenue produced by an extra worker) and is represented by the red
MRP curve in the diagram. The right-hand side is the
marginal cost of labor (roughly, the extra cost due to an extra worker) and is represented by the green
MC curve in the diagram. It should be noticed that this marginal cost is
higher than the wage
paid to the new worker by the amount
» .
This is because 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 a
MC curve that's
above the 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-maximising 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 should now be contrasted with the equilibrium that would obtain under competitive conditions. Suppose a competitor 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 profits 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. In other words, 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, as shown in the graph.
Welfare implications
The lower employment and wage caused by monopsony power has two distinct effects on the economic welfare of the people involved. First, it redistributes welfare away from workers and to their employer(s). Secondly, it reduces the aggregate (or social) 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 (or net gain from the exchange) 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(s) 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 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
is much smaller than unity even when the discounting period is one year. It follows that, as the long-run (direct) supply elasticity of labour tends to be much higher than the short-run one, this very simple dynamic model predicts an exploitation rate which is much smaller than the one produced by static analysis.
However, less simplified dynamic models tell less simple stories. Even the employment effect of minimum wages isn't as clear cut as static models would have.
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 wages
The results of these empirical works are rarely unambiguous. However, even in cases such as coal miners or nurses, most US studies suggest rates of exploitation probably lower than marginal tax rates on workers' incomes, or union relative wage effects. The better documented instances of significant exploitation are found in the probably rare cases of explicit collusion, such as US baseball before the reserve clause.
The sources of labour monopsony power
The simpler explanation of monopsony power in labour markets is barriers to entry on the
demand side. In all such cases, oligopsony would result from
oligopoly in the product markets of the industries that use that type of labour as input. If the hypothesis was generally true, one would then find a positive statistical correlation between exploitation, on one side, and industry concentration and firm size on the other. However, numerous statistical studies document significant positive correlations between firm or establishment size and
wages. These results, by themselves inconsistent with the oligopoly-oligopsony hypothesis, may be due to the prevalence of other factors, such as
efficiency wages.
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. Paramount among these are moving costs for workers, which are also a cause of differentiation among potential employees, possibly leading to discrimination (see above). But a similar effect might also be produced by all the institutional factors that limit labour mobility between firms, including
job protection legislation. Finally, as already noticed, a significant reduction in the short-run elasticity of supply may come from information costs and search behaviour.
An alternative that has been suggested as a source of monopsony power is worker preferences over job characteristics (Bhaskar and To, 1999; Bhaskar, Manning and To, 2002). Such job characteristics can include distance from work, type of work, location, the social environment at work, etc. 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 attempts to identify significant monopsony in non-labour markets, and specifically in markets for intermediate goods bought as inputs by very large firms. Among the most likely US candidates, one finds in the literature:
» *trade in technological knowledge: Rodriguez (1975)
*tomatoes for tomato processing: Just and Chern (1980)
» *beef for the beef packing industry: Schroeter (1988)
*western coal for electric utilities: Atkinson and Kerkvliet (1989)
» *pulpwood and sawlogs: Murray (1995)
*sophisticated weaponry (for example 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. It has been argued that vertical integration by a monopsony – whereby the production of the previously bought input becomes an in-house operation – may reduce or eliminate the inefficiencies due to monopsonistic restriction of purchases.
In
Australia, the Pharmaceutical Industry can be viewed as a kind of monopsony, as the
Commonwealth government is the principal buyer of products through the
Pharmaceutical Benefits Scheme (PBS)
In the US, several, including
Harper's and the
PBS program
Frontline, have made the case 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
(External Link) (External Link).
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