Monopsony

Monopsony Graph

Before diving into the monopsony graph, we need to discuss three essential concepts: marginal expenditure, average expenditure, and marginal value.

Whether you are a buyer with competitive power or a buyer with monopsony power will determine what that marginal expenditure is.

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.

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.

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.

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.

A monopoly is an imperfect market condition in which the inefficient allocation of resources occurs.

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.

Monopsony Example

One of the most common monopsony examples is a company town.