Market Structure #6

Hi Everyone,

My series on market structure continues in this post with ‘monopsony’. Monopsonies are generally not discussed in great detail. This is because there are not many real life examples or many other market structures that have real life examples that are similar to monopsonies. Perfect competition also lacks real life examples but has strong theoretical relevance. Monopsonies generally do not have this significance. There are other interesting implications of monopsonies that should still be discussed. This post will take a closer at these implications.

Quick recap

Before I go into detail regarding monopsony, I would like to provide a quick recap of the series so far. The series began about 3 month ago. I started the series with a brief introduction to market structures. I have also covered perfect competition, monopolistic competition, oligopoly and monopoly market structures. The introduction post provided a brief outline of the six market structures that I am covering in the series. The other posts delved into a lot more detail regarding each market structure.

The market structures covered in this series are as follows:

Perfect Competition
Monopolistic Competition
Oligopoly
Monopoly
Monopsony
Oligopsony

The first four market structures in the list are typically discussed in detail in textbooks and schools. Monopsony is sometimes discussed but in less detail. Oligopsony is rarely discussed. I will be covering oligopsony because of its real life relevance to Steemit and the Steem platform. Most of the theory described in the monopsony post applies to oligopsonies as well. This will be a useful post to reference in the future.

What is the monopsony market structure?

A monopsony has only one buyer and usually many sellers. This means that the buyer has complete control over price and quantity. This is the opposite of a monopoly. Like a monopoly, quantity is normally below the allocative efficient desired quantity. Unlike a monopoly, price is set below the allocative efficient price.

There are normally very few barriers to entry in regards to the sellers, though low prices can be considered as a deterrent. There are likely to be quite strong barriers to entry for the buyer or there are no other buyers interested in what the sellers are offering. Monopsonies are not profitable to sellers in either the short-run or the long-run.

Monopsonies are rare. The military can be considered, in part, a monopsony for certain weapons that there is no demand for elsewhere. The most likely example for a monopsony is in the labour market where there is just one employer for labour of a particular skill or just one employer in a particular community.

Monopsony Pricing

Monopsonies aim to maximise their consumer surplus. Consumer surplus maximisation can be achieved by setting quantity equal to the point where marginal cost equals demand (marginal revenue product in regards to demand for labour). Price is then set at the average cost (supply) of the quantity determined using marginal cost and demand as described above. Figure 1 explains how this is achieved.

Figure 1 : Monopsony Prices

The figure also shows the deadweight loss from the restriction of quantity as well as the transfer of surplus from producer to consumer. The deadweight loss is the total loss of consumer and producer surplus from not producing at the allocative efficient quantity. The monopsonist loses consumer surplus equal to the yellow area from buying a quantity below the allocative efficient quantity. Overall, the monopsonist gains a higher consumer surplus based on this decision, as the black area (surplus transferred to the buyer from the seller is greater than the yellow area; this can be supported mathematically but I will not cover that in this post). The seller loses producer surplus to deadweight loss (red area) and producer surplus to the buyer (black area). A monopsony generally results in a bad outcome for the seller as can be seen from the extent of the loss of surplus.

Examples of Monopsony

Monopsonies are most likely to occur in the labour market. A single or near single buyer of labour is typically called a monopsony employer. A monopsony employer could be for a whole community or for just a particular part of the workforce. Unskilled workers with limited geographical mobility are more likely to be employed by a monopsony because of lack of choice in regards to alternative employment.

Monopsonies are more likely to exist in developing countries. Both the Government and large private corporations can be culprits of providing a monopsony environment. Lack of union representation or any other form of collective bargaining increase the power of monopsonies and also the likelihood of monopsonies being created. Unionism in developing countries also brings about its own problems; this is a discussion for another day.

Highly skilled workers generally have more options and greater means to find alternative sources for employment. It is still possible that workers with a very specific skill set that is not transferable to other work could still end up seeking employment from a monopsony. In these cases, wages are likely to remain high because of the value added by the specialist skills of these employees.

Are monopsonies bad?

Monopsonies have many of the same problems as monopolies. Instead of the sellers exploiting the buyers, the buyers are now exploiting the sellers. This is especially true for labour markets dominated by one buyer of a labour. Majority of people require some form of income in order to survive. Therefore, people are forced into the labour market. If the number of people entering the labour market is less than monopsony’s desired number of employees (quantity), the price of labour is forced down. All entering the workforce may have the opportunity for employment if everyone is willing to work for less money. Figure 2 shows the original allocative efficient quantity of labour being achieved from reduced wages.

Figure 2: Achieving employment with monopsony power

Large multinational corporations (MNC) have displayed monopsonistic power in developing countries where high unemployment exists. The MNC offers employment at a very low wage. As there very few alternative employment options and lack of union representation, people are forced to accept whatever pay conditions are offered. To compound the problem, working hours offered are often very long. This reduces the number of employees required and increases competition for jobs, hence lowering wages further.

Implementing a minimum wage

Implementing a minimum wage typically raises wages but lowers employment. This is because minimum wages increases the cost of labour and generally the overall costs of production. Firms can respond by reducing output or by substituting labour for more capital (machines, equipment, technology, etc). Most likely firms will reduce output.

Implementing minimum wages for a monopsony could increase both wages and employment, how is this possible? Monopsonies hire less workers because marginal cost exceeds marginal revenue product (cost of hiring one more person is greater than revenue obtained from that person’s additional output). The marginal cost is high because hiring an extra worker also involves not only paying an extra worker but also the cost of increasing the wages of all existing workers (assuming wages for all workers employed are equal). If a minimum wage is implemented, the firm only incurs the cost of hiring the extra worker (this is based on the assumption that the minimum wage is higher than the average wage prior to the implementation of the minimum wage) as wages of the other workers are not affected (still receiving minimum wage). Figure 3 explains the increase in wages and quantity.

Figure 3: Minimum wage implementation for a monopsony

In the figure above, P3 is higher than both the initial monopsony wage (P2) and the competitive wage (P1). Quantity of workers hired is less than the competitive number hired (Q1) but more than the monopsony quantity of workers hired (Q2).

Implementing a minimum wage, if the monopsony employer has geographical mobility of production or operations (e.g. MNC), could result in the permanent loss of employment opportunities in that region. It is possible that minimum wage, if sufficiently high could result in the MNC moving operations elsewhere which could result in a massive loss of jobs.

Key points of post

The following are key points that you should take away from this post.

Monopsony is a market structure that normally has many sellers and just one buyer.
Monopsony sellers do not produce an allocative efficient price or quantity for goods or services. Monopsony buyers control the market price and quantity.
Monopsony sellers do not produce profits in either the short-run or the long-run.
There are no barriers to entry other than the zero profits made by existing sellers.
There are very few real world examples of monopsonies. Some markets for the sale of weapons to the military can be considered a monopsony. Monopsonies most likely exist in labour markets where there is just one employer for a particular skill or particular group of people.
Monopsony buyers aim to maximise their own consumer surplus at the expense of the monopsony sellers.
Monopsony for labour could also double up as a monopoly for the output produced by the labour. The sole employer of labour to produce a good/service could also be the sole seller of that good or service.
Applying minimum wages to a monopsony employer can increase both wages and employment if the minimum wage is not higher than the marginal cost of employing an extra worker or lower than the average wage prior to the implementation of the monopoly.
Applying minimum wages to a monopsony employer that has geographical mobility such as an MNC, could result in an almost total loss of jobs to a community.

Thank you for taking the time to read this post. Monopsonies are a very strange form of market structure. This is the first market structure I have covered where the buyer/s control the market price and quantity rather than the seller/s. This post also demonstrates along with the monopoly post that efficient outcomes cannot be reached if either buyers or sellers have too much control over prices and quantity.

My next and final post in the series will be on oligopsony. Oligopsony is almost never discussed but it is the type of market structure that the Steem platform is starting to resemble for many authors. I have been building up for this final post in the series for some time now, I hope you enjoy the read.

The links below contain the other posts in this series. To get a better idea regarding market structures as well as some of the terminology used in this post, please take a look at the other posts in this series.

If you want a quick overview of the market structures I am covering in this series, you can use the link below to view the introduction post.