Monopsony: Mathematical and Graphical Explanation with real-life examples.

By Saad Bin Abbas

Our discussions of market power have been only focused on the seller side of the market. Now we will discuss the buyer side. We will see the term Monopsony, that if there are not too many buyers in the market, so they can also have the market power like sellers and they can also use it profitably to affect the price they pay for a product. Firstly, we will see a few terms.

• A market in which only one buyer dominates the market power called Monopsony.
• An Oligopoly is a market with only a few buyers.
• Some buyers really may have Monopsony power, with one or only a few buyers. A buyer’s capacity to affect the price of a good. Monopsony power empowers the buyer to pay less for a good for less than the price that would prevail in the competitive market.

Marginal Principle in Monopsony:

Suppose you are trying to sort out how much of a good to purchase. You could apply the basic marginal principle-keep purchasing goods until the last unit purchased gives you additional utility or value. Just equal to the cost of the last unit. In other words, additional benefits should be offset just by additional costs on the margin.

Let’s see the additional benefit and additional cost in more detail. We use the term marginal value to refer to the additional benefits from purchasing one more unit of a good. How can we determine the marginal value? As we know individual demand curve determines marginal value, or marginal utility, as a function of the quantity purchased. Therefore, your marginal value index is your demand curve for the good. The demand curve of an individual always slopes downwards because he can obtain marginal value from buying one more unit of a good decline as the total quantity purchased increases.

Marginal Expenditure in Monopsony:

Marginal Expenditure is defined as the additional cost of buying one more unit of a good. What that marginal expenditure id depends on whether you are a competitive buyer a buyer with monopsony power. Imagine you are competitive buyer-in other words, you have no influence on the price of the goods. In that case, the cost of each unit you buy is the same no matter how many units you purchase; it is the market price of the good.

Average Expenditure in Monopsony:

The price you are paying per unit is your Average Expenditure per unit, and it is the same for all units. But what is your marginal expenditure per unit? As a competitive buyer, you have to make your marginal expenditure equal to your average expenditure, which in turn is equal to the market price of the good.

Competitive buyer compared to a competitive seller in Monopsony:

Figure 1(a) also shows you the marginal value index. How much of the good should you buy? You have to buy until the marginal value of the last unit is just equal to the marginal expenditure on that unit. Thus you should purchase Q* at the intersection of the marginal expenditure and demand curves. We introduced the concepts of Marginal and average expenditure because they will make it easier to understand what happens when buyers have monopsony power. But before considering this situation, let’s took the analogy between competitive buyer’s conditions and competitive seller’s conditions.

Figure 1(b) shows how a perfectly competitive seller decides how much to produce and sell. Because the seller takes the market price as given, both average and marginal revenue are equal to the price. The profit-maximizing quantity is at the intersection of the marginal revenue and marginal cost curves.

Graphical Explanation of a Monopsonist Buyer:

Now suppose that you are the only buyer of the good in the market. Again you face a market supply curve, which tells you how much producers are willing to sell as the function of the price you pay. Should the quantity you purchase be at the point where your marginal value curve intersects the market supply curve? No. if you want to maximize your net benefit from purchasing the good, you should purchase a smaller quantity, which u will obtain at a lower price.

If we have to determine how much to buy the units, set the marginal value from the last unit purchased equal to the marginal expenditure on that unit. Note, however, that the market supply curve is not the marginal expenditure curve. The market supply curve shows how much you must pay per unit, as the function of the total number of units you buy. In other words, the supply curve is the average expenditure curve. And because the curve of average expenditure is upward sloping, the marginal Expenditure curve must lie above it. The decision to buy extra units raises the price that must be paid for all units, not just an extra one.

Figure 2 shows this principle. The optimal quantity for the monopsonist to buy Q*m is found at the intersection of the demand and marginal Expenditure curves. The price that Monopsonist pays is found the supply curve: it is the price P*m that brings forth the supply Q*m. Finally, note that this quantity Q*m is less, and the price P*m is lower than the quantity and price that would prevail in a competitive market, Qc, and Pc.

Mathematical Explanation of Monopsonist Buyer:

Mathematically, we can write the net benefit NB from the purchase as NB = V — E where V is the value to the buyers of the purchase, and E is the Expenditure. The net benefit is maximized when ∆NB/∆Q = 0. Then

∆NB/∆Q = ∆V/∆Q — ∆E/∆Q = MV — ME = 0

To obtain the marginal expenditure curve algebraically, write the supply curve with the price on the left hand: P = P (Q). Then E is price times quantity of total Expenditure or E = P (Q) Q, and marginal expenditure is

ME = ∆E/∆Q = P (Q) + Q (∆P/∆Q)

Because the supply curve is upward sloping, ∆P/∆Q is positive, and marginal expenditure greater than average expenditure.

Real-Life Examples of Monopsony:

Amazon, Uber, Bigbasket, Swiggy, etc are the new-age companies who have the Monopsony power and their power is increasing with the passage of time -it’s leading to more wage discrimination and social stratification and more value-added by the workers is getting transferred to owners of capital for whom they work. The consequences are that Monopsony is one of the leading factors in income inequality in the world.

Originally published at https://www.studentsofeconomics.com.