Monopsony Definition Power Market Examples Graph

Monopsony Definition

Factor price refers to the factor of production—the resources people use to produce goods and services. If there is a single employer in the labor market, the business can take undue advantage. Imposing a minimum wage directly or enforced by law can safeguard labor. Usually, fixed minimum wage reduces employment, but in a monopsonistic market, employment increases.

Key Takeaways

Monopsony is similar to a monopoly; it hinders the competitive market and distorts prices. It results in lower wages for labor and huge profits for the dominant employer. In such a market, employers maximize profits by discriminating prices. The employer pays different wages to different groups of workers for the same work. Lower wages are paid to those workers who struggle to find employment elsewhere.One solution to low wages in such a market is the introduction of minimum wages for labor. Minimum wage, if set at an appropriate level, can result in both increase in wages for the labor as well as an increase in employment.

How Does Monopsony Market Work?

Monopsony is an imperfect marketImperfect MarketImperfect market structure is a part of microeconomics in which companies sell different products and services, as opposed to perfect competitive markets in which homogeneous products are sold. Companies in this sector have some pricing power with high barriers to entry, resulting in higher profit margins as each company tries to differentiate their products and services through innovative technology.read more condition. It does not follow demand and supply when it comes to determining prices. Let us try to understand the factor pricing in monopsony and how it reduces the factor cost with the help of a graph.

You are free to use this image on you website, templates, etc., Please provide us with an attribution linkHow to Provide Attribution?Article Link to be HyperlinkedFor eg:Source: Monopsony (wallstreetmojo.com)

As shown above, in a perfectly competitive market, the price of the factor (FP) would have been fixed. Here demand (D)/Marginal Revenue Product (MRP) is equal to supply (S).Also, the MFC curve is steeper than the supply curve. This implies that any further increase in factor results in relatively much higher Marginal Factor Cost (MFC). The marginal factor cost is the increment to total costs paid for a factor of production resulting from a one-unit increase in the amount of the factor employed. The factor quantity at which the profit would be maximum will be at the point where marginal revenueMarginal RevenueThe marginal revenue formula computes the change in total revenue with more goods and units sold." The value denotes the marginal revenue gained. Marginal revenue = Change in total revenue/Change in quantity sold.
read more is equal to the marginal costMarginal CostMarginal costing in economics and managerial accounting refers to an increase or decrease in the total cost of production due to a change in the quantity of the desired output. It is variable, depending on the inclusion of resources required to produce or deliver additional unit(s) of a product or service.read more, i.e. (FQm) in the curve.The marginal cost of employing labour is the change in total labour costs from employing one extra worker. The marginal revenue of labor is the additional amount of revenue a firm can generate by hiring one additional employee. Further, plotting a line from point P to the Supply curveSupply CurveSupply curve represents the relationship between quantity and price of a product which the supplier is willing to supply at a given point of time. It is an upward sloping curve where the price of the product is represented along the y-axis and quantity on the x-axis.read more (S), the intersection determines the Factor price, which is FPm in this case. Here MFC=MRP or the quantity where profit is maximum. Factor price is the unit cost of using a factor of productionFactor Of ProductionFactors of production define resources used to produce or create finished goods and services, the sale and purchase of which keeps the market economy afloat.read more, such as labor or physical capital.

Monopsony Examples

This condition can exist in almost any kind of market and can affect the prices of various factors of production.

Following are real-time examples of monopsony:

Food supermarket retail brands like Walmart are the most common example of monopsony. A single retailer has a huge buying powerBuying PowerBuying power in trading refers to the funds available in the trading account to trade stocks, cryptocurrencies, options, etc. It includes the money held in the brokerage account and the margin available. A change can greatly affect security prices in the financial market in different forms, such as discount rates.read more due to his deep pockets. Thus, these retailers control the prices at which farmers sell their produce.Another example could be China negotiating the prices of minerals. China buys them from low-income African countries. This again is down to China’s massive purchasing power.Generally, the Government of a country uses its immense purchasing power to negotiate the price of the deals while purchasing technologies or equipment. Governments can act like a monopsony in the labor marketLabor MarketThe labour market, also known as the job market, is a well-studied market that operates on the supply and demand dynamics of people looking for work (workers) and organizations/people providing work (employers).read more. This is seen in the hiring of Federal employees as well.If a country has only one electricity producing company, then that company can control or negotiate the buying price of coal.

Monopsony Power

A monopsony is usually a very large entity or a firm with huge buying power. In such a market scenario, very few alternatives are available to the suppliers and producers. This is the cause of immense bargaining power. Ultimately factor cost is reduced, and the company’s profit marginProfit MarginProfit Margin is a metric that the management, financial analysts, & investors use to measure the profitability of a business relative to its sales. It is determined as the ratio of Generated Profit Amount to the Generated Revenue Amount. read more increases. Factor price is the unit cost of using a factor of production, such as labor or physical capitalPhysical CapitalPhysical capital refers to tangible assets used to develop or build final goods and services. It is an essential element for most manufacturing processes. Unlike human capital, its value can diminish over time because of the continuous use of physical items, such as machines, equipment, vehicles, computers, buildings, etc., in production. read more.

Labor Market

Monopsony in the labor market occurs when one single entity or firm generates a lot of jobs in that particular market. As a result, one single business controls labor wages.

As can be seen in the figure, in a perfectly competitive market, the wage (W) would have been fixed where demand (D)/ Marginal Revenue of Labor (MRL) is equal to the supply of labor.Also, the Marginal Labor Cost (MLC) curve is steeper than the supply curve. This implies that any further increase in labor costs much higher. We assume that an increase in the wage of each additional labor will eventually result in increased wages for all the laborers.The quantity of labor where the profit would be maximum will correspond to the point where marginal revenue is equal to the marginal cost, i.e., FQm in the curve.The wage of the labor can be determined by plotting a line from point P (MLC=MLR) to the supply curve (S). The intersection on the Supply curve determines the wage—Wm.

The concept of a minimum wage was introduced to rectify this. In an ideal scenario, fixing a minimum wage for labor should result in unemployment, but reverse effects are observed in the real world.

Let’s understand why this happens with the help of a graph.

From the figure:

The original wages and quantity of labor employed as per monopsony were at Wm and Qm, respectively (refer to the previous graph).If the wages are now fixed to a minimum at W, the marginal cost of labor will remain constant. The marginal cost of employing labour is the change in total labour costs from employing one extra worker. Therefore, employers will benefit maximum when the marginal labor cost is equal to marginal revenue of labor—denoted by point O1 on the curve. The marginal revenue of labor is the additional amount of revenue a firm can generate by hiring one additional employee. Plotting line from point O1 to its corresponding point on the Supply curve corresponds to point O, and thus the quantity of labor has increased from Qm to Q.Again, if the minimum wage is further increased to W1, following the steps as mentioned in point 2, the quantity of labor will decrease back to Qm.