Imagine going to your local store and deciding how much you would pay for the chocolate bar they sell. Of course, this is unlikely, as your local store has many other buyers willing to buy the product at the price the local store sells. But what if you were the only buyer and no one else bought from that local store? Most likely, you could negotiate the price. This is what is known as a monopsony. Monopsony is a type of market where there is only one buyer, and the buyer can influence the price. You might wonder how a buyer can influence the price or even if these markets exist in the real world. To find that out, you need to know all there is about the market structure of a monopsony. You can learn all about it by getting to the bottom of this article!
Monopsony Definition
Monopsony's definition refers to a market where there is only one buyer, and the buyer is capable of influencing the price. There are cases, such as in a monopoly, where the price is affected by the seller; on the other hand, there are cases, such as in a monopsony, where the buyer influences the price. That is to say that in a monopsony, the market power is in the hands of the buyer rather than the seller.
Monopsony is a market that has only one buyer, and the buyer is capable of influencing the price.
The buyer is known as a monopsonist, and it is monopsony power that allows it to bring the price down to its desired rate.
Monopsony power is the buyer's ability to affect the price of the goods they buy.
There are many different contexts in which a monopsony could take place. In a monopsony context, the buyer acts as the primary driver of the market. Because so many suppliers compete for this buyer's business, the buyer may be able to take advantage of its scale to negotiate favorable pricing.
In labor markets, monopsony may also be prevalent when a single employer is a leading firm that demands labor.
When this occurs, the wholesalers, who, in this context, would be the prospective workers, agree to accept a lower payment due to reasons that are within the control of the firm demanding labor. The employer's costs are reduced due to this wage control, resulting in increased profit margins.
For example, in a local area where you have a significant company as the leading supplier of jobs, the firm is a monopsonist.
That's because the firm has the ability to determine pay levels as workers in that area don't have many other firms where they could find employment opportunities.
In addition to determining the wage, the company, which is the sole provider of jobs, has the ability to negotiate working conditions as they have monopsony power.
In addition to a monopsony, there is also oligopsony.
Oligopsony is a market that contains few buyers who are capable of influencing the price.
Oligopsonies usually form when there is a concentration of demand amongst a few buyers. They are much more common than monopsonies.
Does any oligopsony example come to your mind? Well, think about the big fast food chain restaurants like McDonald's, Burger King, and Wendy's in the United States. As these are the largest buyers of meat produced in the United States, they can influence its price.
Monopsony Graph
Before diving into the monopsony graph, we need to discuss three essential concepts: marginal expenditure, average expenditure, and marginal value.
The marginal expenditure refers to the extra expense that is incurred when purchasing one more unit of an item.
The marginal expenditure a firm faces depends on whether the firm is a competitive buyer (meaning it is in a competitive market) or whether the firm has monopsony power (the firm is the single buyer).
Whether you are a buyer with competitive power or a buyer with monopsony power will determine what that marginal expenditure is.
The average expenditure is the cost per unit a firm pays.
Marginal value refers to a firm's additional value from buying an additional product.
Imagine you own a firm that is the only buyer of goods in a particular market. The market has a supply curve and a demand curve.
Fig. 1 - Monopsony Graph
Figure 1 shows the monopsony graph. Note that the monopsony graph has three crucial curves.
- The supply curve, which is equal to the average expenditure (AE);
- The demand curve, which consists of the marginal value (MV);
- Marginal expenditure curve (ME).
The monopsony supply curve is equal to the average expenditure as it shows how much your company has to pay for every unit it buys. If your company decides to increase the number of goods it buys, the average expenditure also increases.
The marginal expenditure is above the average expenditure as the expense of buying one more product increases over time.
When a monopsony firm decides how much quantity to purchase and for what price, they don't play by the equilibrium rule. That is to say, a company with monopsony power will not purchase quantity Q1 and pay P1 for it at the point where demand and supply intersect.
As the company has monopsony power, it can bring the price down.
The quantity a monopsonist chooses to buy is found at the intersection between the demand curve and marginal expenditure, Q2. The price that the monopsonist pays at this quantity, P2, is found on the supply curve (which is the price it pays for the overall Q2 quantity).
Effects of Monopsony
There are many effects of monopsony. Monopsony forces suppliers to sell at lower prices and causes wages to decrease as it removes all other alternatives that companies can sell to or individuals supply labor to.
We will look at the effects of monopsony by looking at the loss in consumer and producer surplus that results when a market shifts from being a competitive market to being a monopsony.
If you need to refresh your knowledge of consumer surplus and producer surplus, check out our article!
Fig. 2 - Effects of monopsony
Figure 2 shows the movement from a competitive equilibrium to a monopsony equilibrium. Initially, the equilibrium quantity is Q1, and the equilibrium price is P1. Due to monopsony power, the firm decides to buy at price P2, and the quantity is Q2.
Figure 2 shows how surplus changes if we switch from the competitive price and quantity, P1 and Q1, to the monopsony price and quantity, P2, and Q2.
Monopsony decreases the market price, which causes sellers to incur a loss. The loss is presented by rectangle 3. Sellers also lose rectangle 2 as the total quantity they sell falls from Q1 to Q2.
This means that the total loss of producer (seller) surplus is 3+2.
When a company buys at a lower price, they gain the amount shown in rectangle 1. However, as the monopsony buys less, Q1 instead of Q2, triangle 1 shows the total loss that the monopsony firm loses.
Triangles 1 and 2 are known as the deadweight loss of monopsony.
Deadweight loss is the cost that society faces due to market inefficiencies.
The effect of monopsony in society is the cost that sellers lose, and the effect of less production taking place in the economy. The production in a monopsony market is way lower than it would be if the market was in perfect competition.
Check out our article on Perfect Competition to discover more!
Monopsony vs. Monopoly
The main difference between monopsony vs. monopoly is that in a monopsony, you have only one buyer, whereas, in a monopoly, you have only one seller.
Although it is not common, there are instances in which the market is tilted toward buyers or sellers.
Monopoly is a term used to describe a market state in which only one producer exists in a particular industry. The customers do not have any alternative from where to purchase their goods or services.
A monopoly is an imperfect market condition in which the inefficient allocation of resources occurs.
To find out more about Monopoly, check out our article!
The state known as monopsony, where there are numerous sellers but only one buyer, is the opposite of perfect competition and an imperfect market scenario.
Situations of imperfect competition are conditions in which a single company may affect what would otherwise be a free market where the equilibrium price and quantity are set based on the intersection of demand and supply. In a monopsony, as well as in a monopolistic market, a single firm is capable of changing the market from being a perfectly competitive market to an imperfect market.
The main difference between these two is whether the market is imperfect due to demand or supply. The one thing that is solely controlled in a monopoly scenario is the supply of the products or services, but in a monopsony scenario, it is the demand for the things.
It should come as no surprise that neither monopoly nor monopsony is in customers' best interest. Both monopsony and monopoly cause inefficiencies in the market.
Consider the case of the distribution of energy in a nation that is under the jurisdiction of the government. Because customers have no choice but to use the services offered by the government, this is an example of a monopoly.
Because there is no other option, the government is free to set electricity prices at will (there is no competition), and customers must pay for the services.
Monopsony Example
One of the most common monopsony examples is a company town.
A company town refers to a company that owns the majority of businesses in a town, which makes it the community's only source of employment.
As the company town is the main, and sometimes the only provider of jobs, it has leverage over the labor market. Individuals do not have any other source of getting a job, making them unable to negotiate their wages with the company town.
The company town is then able to influence the price (wage) it pays for the labor services they receive. The monopsony power that the company town has enables it to pay its employees below their marginal product of labor, which is the wage they would have been paid in a perfectly competitive market.
Monopsony - Key takeaways
- Monopsony is a market that has only one buyer, and the buyer is capable of influencing the price.
- Monopsony power is the buyer's ability to affect the price of the goods they buy.
- The monopsony supply curve is equal to the average expenditure as it shows how much a company has to pay for every unit it buys.
- The main difference between monopsony vs. monopoly is that in a monopsony, you have only one buyer, whereas, in a monopoly, you have only one seller.
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