Monopsony Market Structure

Introduction

Moving on to a form of market that is focusing on the buyer side of the market. If there are not too many buyers, then the buyers have market power that they can use it profitably to affect the price of the product they purchase.

Monopsony is a market structure where there is a single buyer of the product of the market in the market. This market power enables the buyer to purchase the good at less than the price that is prevailing in the competitive market.

Monopsony Market

Monopsony is a market structure which was first introduced by Joan Robinson in 1933 in her book, “The Economics of Imperfect Competition”. She was awarded as classics scholar Bertrand Hallward at the University of Cambridge for this contribution.

Monopsony is a market structure where there is a single buyer and many competing sellers. This market power enables the buyer to purchase the good at less than the price that is prevailing in the competitive market.

In order to find equilibrium under a monopsony market structure, we need to introduce two terms, i.e. average expenditure and marginal expenditure. The monopsony is in equilibrium where marginal value is equal to marginal expenditure. In order to understand the average expenditure and marginal expenditure concept, we are using the concept of the competitive buyer.

In the market structure, we have seen that in order to decide how much of a good to purchase we used the marginal principle rule. Under the marginal principle rule, marginal revenue is equal to marginal cost i.e. additional benefit equals additional cost. And demand curve measures the marginal value as a function of the quantity purchased.

In a competitive market, each buyer is so small in terms of the market as a whole that it cannot influence the market. Each individual buyer has no influence on the price of the product, and each buyer can purchase whatever amount he wants to buy at the industry-determined price. The cost of each unit the buyer purchase is equal to the price of the product.

The price per unit paid by the buyer is known as the average expenditure. The average expenditure remains the same for all units as the price per unit paid by the buyer is the same.

On the other hand, marginal expenditure is the addition to total expenditure attributable to the purchase of one more unit of a good. In a competitive market, average expenditure is equal to marginal expenditure. They both are straight line parallel to the horizontal axis.

But the same is not true for monopsonists. Under monopsony, the price that a monopsonist pays for each quantity purchased is given by the market supply curve of the inputs. The supply curve for most inputs is positively sloped, i.e. upward sloping. The positively sloped supply curve indicates a positive relationship between price and quantity purchased. The curve shows how much price per unit buyers are paying for the good, which is a function of the number of units buyers purchase.

So, the supply curve is the average expenditure curve. The average expenditure curve, like the market supply curve, is upward-sloping. The marginal expenditure must lie below the average expenditure curve because the decision to buy an extra unit raises the price that must be paid for all units and not just the extra one.

We can obtain marginal expenditure algebraically. The supply curve shows the relationship between price and quantity supplied. So,

𝑃 = 𝑓(𝑄)

Total expenditure is price multiplied by quantity i.e.

𝐸 = 𝑃𝑥𝑄

Marginal expenditure in addition to total expenditure attributable to the purchase of one more unit of good i.e.

We know that the supply curve is positively sloped, so ∆𝑃/∆𝑄 is positive, so marginal expenditure is greater than average expenditure (ME>AE).

The monopsonist is in equilibrium where marginal value is equal to marginal expenditure. It is shown in the figure. Price is measured on X-axis, and quantity on Y-axis. AE is the average expenditure curve, ME is the marginal expenditure curve, and MV is the demand curve which shows the marginal valuation.

The equilibrium would occur at point E, where the Marginal value curve intersects the marginal expenditure curve. The equilibrium price is OP*, and the equilibrium quantity is OQ*. The monopsonist is buying the optimal quantity OQ* at price OP*. The quantity and price that prevail in a monopsony market are lower than the price and output that would prevail in a competitive market.

Figure: The monopsonist is in equilibrium where marginal value is equal to marginal expenditure. The equilibrium occurs at point E, the equilibrium price is OP*, and the equilibrium quantity is OQ*.

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