Monopsony

Monopsony

Overview
In economics
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...

, a monopsony is a market form in which only one buyer faces many sellers. It is an example of imperfect competition
Imperfect competition
In economic theory, imperfect competition is the competitive situation in any market where the conditions necessary for perfect competition are not satisfied...

, similar to a monopoly
Monopoly
A monopoly exists when a specific person or enterprise is the only supplier of a particular commodity...

, in which only one seller faces many buyers. As the only or majority purchaser of a good or service, the "monopsonist" may dictate terms to its suppliers in the same manner that a monopolist controls the market for its buyers.

A monopsony is a market condition where multiple sellers, [the majority of sellers in that market] all have to sell to the same individual buyer because that buyer is buying a significant portion of the entire market.
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In economics
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...

, a monopsony is a market form in which only one buyer faces many sellers. It is an example of imperfect competition
Imperfect competition
In economic theory, imperfect competition is the competitive situation in any market where the conditions necessary for perfect competition are not satisfied...

, similar to a monopoly
Monopoly
A monopoly exists when a specific person or enterprise is the only supplier of a particular commodity...

, in which only one seller faces many buyers. As the only or majority purchaser of a good or service, the "monopsonist" may dictate terms to its suppliers in the same manner that a monopolist controls the market for its buyers.

A monopsony is a market condition where multiple sellers, [the majority of sellers in that market] all have to sell to the same individual buyer because that buyer is buying a significant portion of the entire market. This gives the buyer the advantage because the buyer can keep asking each seller to match or undercut the competing sellers prices, thus driving down the prices of the products in that market. One modern instance of this happening is the "wholsesale Ebooks" marketplace and Amazon.com. Ebooks now make up 40% of the book publishing market. All the major book publishers have been forced to give deep discounts to Amazon.com because Amazon buys so many ebooks. If they decided not to sell to Amazon, it would reduce their income so much that it could shut their company down.

A monopoly is an individual seller selling to multiple buyers.

Origin of term


The term was first introduced by Joan Robinson
Joan Robinson
Joan Violet Robinson FBA was a post-Keynesian economist who was well known for her knowledge of monetary economics and wide-ranging contributions to economic theory...

 in her influential book, The Economics of Imperfect Competition. Robinson credits classics scholar Bertrand Hallward
Bertrand Hallward
Bertrand Hallward was the first Vice-Chancellor of the University of Nottingham.Hallward was a pupil at Haileybury College, an undergraduate at King's College, Cambridge and a Classics don at Peterhouse, Cambridge prior to becoming headmaster of Clifton College...

 at the University of Cambridge with coining the term.

Examples


A single-payer universal health care
Single-payer health care
Single-payer health care is medical care funded from a single insurance pool, run by the state. Under a single-payer system, universal health care for an entire population can be financed from a pool to which many parties employees, employers, and the state have contributed...

 system, in which the government is the only "buyer" of health care services, is an example of a monopsony. It has also been argued that Wal-Mart
Wal-Mart
Wal-Mart Stores, Inc. , branded as Walmart since 2008 and Wal-Mart before then, is an American public multinational corporation that runs chains of large discount department stores and warehouse stores. The company is the world's 18th largest public corporation, according to the Forbes Global 2000...

, in the United States, functions as a monopsony in certain market segments, as its buying power for a given item may dwarf the remaining market. Another possible monopsony could develop in the exchange between the food industry
Food industry
The food production is a complex, global collective of diverse businesses that together supply much of the food energy consumed by the world population...

 and farmers.

The defense aircraft industry in USA is a monopsony where there is only one buyer which is the US government and there are several sellers such as Lockheed Martin
Lockheed Martin
Lockheed Martin is an American global aerospace, defense, security, and advanced technology company with worldwide interests. It was formed by the merger of Lockheed Corporation with Martin Marietta in March 1995. It is headquartered in Bethesda, Maryland, in the Washington Metropolitan Area....

, Boeing
Boeing
The Boeing Company is an American multinational aerospace and defense corporation, founded in 1916 by William E. Boeing in Seattle, Washington. Boeing has expanded over the years, merging with McDonnell Douglas in 1997. Boeing Corporate headquarters has been in Chicago, Illinois since 2001...

, and Northrop Grumman
Northrop Grumman
Northrop Grumman Corporation is an American global aerospace and defense technology company formed by the 1994 purchase of Grumman by Northrop. The company was the fourth-largest defense contractor in the world as of 2010, and the largest builder of naval vessels. Northrop Grumman employs over...

.

Overview


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 consumer; alternative terms are oligopsony
Oligopsony
An oligopsony is a market form in which the number of buyers is small while the number of sellers in theory could be large. This typically happens in a market for inputs where numerous suppliers are competing to sell their product to a small number of buyers...

 or monopsonistic competition.

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 (as generally contrasted with an infinitely elastic 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 an MC curve that is 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
Competition
Competition is a contest between individuals, groups, animals, etc. for territory, a niche, or a location of resources. It arises whenever two and only two strive for a goal which cannot be shared. Competition occurs naturally between living organisms which co-exist in the same environment. For...

, to intersection C rather than M. Just as a monopoly
Monopoly
A monopoly exists when a specific person or enterprise is the only supplier of a particular commodity...

 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
Economic surplus
In mainstream economics, economic surplus refers to two related quantities. Consumer surplus or consumers' surplus is the monetary gain obtained by consumers because they are able to purchase a product for a price that is less than the highest price that they would be willing to pay...

. 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
Deadweight loss
In economics, a deadweight loss is a loss of economic efficiency that can occur when equilibrium for a good or service is not Pareto optimal...

. 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 (i.e., taxing employers and transferring the tax revenue to the workers), 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
Minimum wage
A minimum wage is the lowest hourly, daily or monthly remuneration that employers may legally pay to workers. Equivalently, it is the lowest wage at which workers may sell their labour. Although minimum wage laws are in effect in a great many jurisdictions, there are differences of opinion about...

 higher than the monopsonistic wage.

Minimum wage



A binding minimum wage
Minimum wage
A minimum wage is the lowest hourly, daily or monthly remuneration that employers may legally pay to workers. Equivalently, it is the lowest wage at which workers may sell their labour. Although minimum wage laws are in effect in a great many jurisdictions, there are differences of opinion about...

 can be introduced either by law or through collective bargaining, and its possible effects in a special case are shown in the diagram on the right.

Here the minimum wage is w, higher than the monopsonistic w. At this given wage the firm can now hire all the workers it wants, up to the supply curve, so that in the relevant employment range its marginal cost of labor becomes effectively constant and equal to w, as shown by the new black horizontal line MC'. Hence the firm maximizes profits at the new intersection point A, choosing the employment level L, which is higher than the monopsonistic level L. As the reader can check, the rate of exploitation has been reduced to zero.

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 or regimes, according to the value taken by the minimum wage, as is seen by the following table:
Minimum-wage regimes in monopsonistic labour markets
Minimum wage Resulting equilibrium
First regime not higher than monopsony wage unchanged from monopsony
Second regime higher than monopsony wage
but
not higher than competitive wage
at kink of supply curve
Third regime higher than competitive wage at intersection where minimum wage equals MRP


As it is now seen, the example illustrated by the diagram belongs to the third regime. As a result, there is an excess supply of labor – i.e. involuntary unemployment – equal to the segment AB. So, although the exploitation rate has vanished, there is still a deadweight loss to society. This illustrates the problems that may arise when the proper level of the binding minimum wage is not exactly known, or cannot be enforced for political reasons.

Yet, even when it is sub-optimal, a minimum wage higher than the market rate 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. 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 labor markets.

Wage discrimination


Just like a monopolist, a monopsonistic employer may find that its profits are maximized if it discriminates prices. In this case this means paying different wages to different groups of workers even if their MRP is the same, with lower wages paid to the workers who have a lower elasticity of supply of their labor to the firm.

Some researchers have tried to use this fact to explain at least part of the observed wage differentials whereby women often earn less than men
Equal pay for women
Equal pay for women is an issue regarding pay inequality between men and women. It is often introduced into domestic politics in many first world countries as an economic problem that needs governmental intervention via regulation...

, even after controlling for observed productivity differentials. However, all such attempts have had to contend with the statistical fact that in most cases women actually display a higher labor supply elasticity than men.

Some authors have argued informally that, while this is so for market supply, the reverse may somehow be true of the supply to individual firms. In particular, Manning and others have shown that, in the case of the UK Equal Pay Act
Equal Pay Act 1970
The Equal Pay Act 1970 is an Act of the United Kingdom Parliament which prohibits any less favourable treatment between men and women in terms of pay and conditions of employment. It was passed by Parliament in the aftermath of the 1968 Ford sewing machinists strike and came into force on 29...

, implementation has led to higher employment of women. Since the Act was effectively minimum wage legislation for women, this might perhaps be interpreted as a symptom of monopsonistic discrimination.

Dynamic problems


In many real-world situations a monopsonist firm will have to maximise its profits through time, rather than instantaneously as in the previous static model. In all such cases, any short-run outcomes will have to be balanced against longer-run ones, and the resulting equilibrium may differ.

The simplest dynamic model to bring out this idea, used in Boal and Ransom (1997), is one where the supply of labour to the firm reacts to wage changes with a lag, due for instance to information costs and search behaviour. Assume hence that the supply function has a distributed-lag specification, leading to:
,

where the subscript refers to the time period and is increasing in both arguments. Inverting this function gives:
,

with
.

If the firm has a time-discount rate , the present value of profits is now given by:
.

The first-order condition to maximise this present value is:
.

Define next the short-run simultaneous and lagged inverse supply elasticities respectively as:
.

Now, assume these elasticities to be constant over time. Assume further a steady state, with and . Then the first-order condition gives the exploitation rate as:
.

Finally, the steady-state long-run inverse elasticity, , is given by the sum of the two short-run inverse elasticities defined above, and so one has:
.

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 is not 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
Oligopoly
An oligopoly is a market form in which a market or industry is dominated by a small number of sellers . The word is derived, by analogy with "monopoly", from the Greek ὀλίγοι "few" + πόλειν "to sell". Because there are few sellers, each oligopolist is likely to be aware of the actions of the others...

 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
Efficiency wages
In labor economics, the efficiency wage hypothesis argues that wages, at least in some markets, are determined by more than simply supply and demand. Specifically, it points to the incentive for managers to pay their employees more than the market-clearing wage in order to increase their...

.

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. The requirement that employees in the government or the defense sector is another source of monopsonistic competition, as are requirements for professional certification, for example, a medical degree. 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.

Finally, monopsony power will occur when the average revenue product of labor increases with the amount of labor employed, due to economies of scale. In this case, the perfectly competitive solution (workers are paid their marginal revenue product) is not stable. In the long run, the firm may set wages equal to the average revenue product of labor, or engage in wage discrimination, paying wages closer to marginal product to markets (or workers) with higher elasticity of supply.

Monopsony in public administration and 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 (i.e. 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
Australia
Australia , officially the Commonwealth of Australia, is a country in the Southern Hemisphere comprising the mainland of the Australian continent, the island of Tasmania, and numerous smaller islands in the Indian and Pacific Oceans. It is the world's sixth-largest country by total area...

, the Pharmaceutical Industry can be viewed as a kind of monopsony, as the Commonwealth government
Government of Australia
The Commonwealth of Australia is a federal constitutional monarchy under a parliamentary democracy. The Commonwealth of Australia was formed in 1901 as a result of an agreement among six self-governing British colonies, which became the six states...

 is the principal buyer of products through the Pharmaceutical Benefits Scheme
Pharmaceutical Benefits Scheme
The Pharmaceutical Benefits Scheme or PBS is a program of the Australian Government that provides subsidised prescription drugs to residents of Australia. The PBS ensures that all Australians have affordable and reliable access to a wide range of necessary medicines.-History:The PBS was established...

 (PBS)

In the US, journalists, including Harper's
Harper's Magazine
Harper's Magazine is a monthly magazine of literature, politics, culture, finance, and the arts, with a generally left-wing perspective. It is the second-oldest continuously published monthly magazine in the U.S. . The current editor is Ellen Rosenbush, who replaced Roger Hodge in January 2010...

 and the PBS
Public Broadcasting Service
The Public Broadcasting Service is an American non-profit public broadcasting television network with 354 member TV stations in the United States which hold collective ownership. Its headquarters is in Arlington, Virginia....

 program Frontline
Frontline (TV series)
FRONTLINE is a public affairs television program that produces and broadcasts in-depth documentaries about various subjects. Produced at WGBH-TV in Boston, Massachusetts and distributed through the Public Broadcasting Service in the United States, the program has been critically acclaimed and...

, have made the case that Wal-Mart
Wal-Mart
Wal-Mart Stores, Inc. , branded as Walmart since 2008 and Wal-Mart before then, is an American public multinational corporation that runs chains of large discount department stores and warehouse stores. The company is the world's 18th largest public corporation, according to the Forbes Global 2000...

 is a monopsonist, dictating terms to suppliers, whilst at the same time a monopolist dictating terms to consumers - at least in certain market segments .

It has been argued that Apple has in some ways become a monopsonist in that it can dictate terms to suppliers of electronic components.

term origin


(from Ancient Greek μόνος (monos) "single" + ὀψωνία (opsōnia) "purchase")

See also

  • Bilateral monopoly
    Bilateral monopoly
    In a bilateral monopoly there is both a monopoly and monopsony in the same market.In such, market price and output will be determined by forces like bargaining power of both buyer and seller...

  • Canadian Wheat Board
    Canadian Wheat Board
    The Canadian Wheat Board was established by the Parliament of Canada on 5 July 1935 as a mandatory producer marketing system for wheat and barley in Alberta, Saskatchewan, Manitoba and a small part of British Columbia...

    —a (formerly general, now limited) monopsony in agriculture
  • Captive supply
    Captive supply
    Captive supply is a term for that part of the supply that is not owned by a company but is used by the company to maximize its own profits often at the unknowing expense of those who actually own those supplies. This is usually a characteristic of a market that is dominated by one firm or a few...

  • Market forms
  • Minimum wage
    Minimum wage
    A minimum wage is the lowest hourly, daily or monthly remuneration that employers may legally pay to workers. Equivalently, it is the lowest wage at which workers may sell their labour. Although minimum wage laws are in effect in a great many jurisdictions, there are differences of opinion about...

  • Monopoly
    Monopoly
    A monopoly exists when a specific person or enterprise is the only supplier of a particular commodity...

  • Oligopsony
    Oligopsony
    An oligopsony is a market form in which the number of buyers is small while the number of sellers in theory could be large. This typically happens in a market for inputs where numerous suppliers are competing to sell their product to a small number of buyers...

  • Single-payer health care
    Single-payer health care
    Single-payer health care is medical care funded from a single insurance pool, run by the state. Under a single-payer system, universal health care for an entire population can be financed from a pool to which many parties employees, employers, and the state have contributed...

  • WalMart
  • International Lease Finance Corporation
    International Lease Finance Corporation
    The International Lease Finance Corporation is an aircraft lessor headquartered in Century City, Los Angeles, California.It is the world's largest aircraft lessor by value, though ILFC's rival, General Electric's GECAS unit, has more aircraft...