3.4.6 - Monopsony

Meaning and Conditions

A pure monopsony, with literally one buyer, is unusual. More often, exam answers discuss monopsony power: a buyer does not need to purchase 100% of market supply to influence the price it pays. If sellers have very few alternative customers, even a dominant buyer can behave like a monopsonist.

That power is strongest when suppliers are relatively immobile, when new buyers face barriers to entry, and when the buyer has better information or bargaining strength than many small sellers. A remote town with one major employer, the NHS buying many medicines in the UK, or large supermarket chains buying fresh produce are all useful applications because suppliers cannot always switch easily to other buyers.

A monopsonist is a price maker on the buying side. Instead of taking the price of inputs as given, it can reduce the quantity it buys in order to force down the price paid.

Price and Quantity Decisions

To understand monopsony, start with the supply curve from the buyer's point of view. It shows the price that must be paid to attract each quantity of supply, so it acts like an average cost curve for the buyer. Because supply slopes upward, the buyer has to offer a higher price if it wants more units.

The crucial difference from competitive buying is that a monopsonist cannot usually pay the higher price only on the last unit. If it wants more supply, it must raise the price on all units purchased. That means the extra cost of expanding purchases is greater than the supply price of the extra unit.

Moving from 2 units to 3 units does not add GBP12 to total spending. It adds GBP14, because the buyer has to pay GBP12 on all 3 units rather than GBP11 on all 2. This is why the marginal cost of purchasing lies above the supply curve in standard monopsony analysis. In labour markets the same two curves are called the average cost of labour (the labour supply curve) and the marginal cost of labour.

A profit-maximising monopsonist buys up to the point where the value of the last unit to the firm is just equal to this extra cost of expanding purchases. In the standard diagram, the quantity is found where the marginal cost of purchasing curve meets the demand or value curve, and the price paid is then read from the supply curve at that quantity.

For example, suppose the buyer values the four units in the table at GBP20, GBP18, GBP15 and GBP14, and a fifth unit (which would need a price of GBP14) at only GBP10. The third unit is worth GBP15 and adds GBP14 to spending, so it is bought. The fourth is worth GBP14 but would add GBP16, so the monopsonist stops at 3 units and pays GBP12 per unit, the supply price for 3 units.

Competitive Comparison

In a competitive buying market, price and quantity are set where supply and demand meet. The buyer has no reason to restrict purchases, so suppliers receive the competitive price and the market trades the competitive quantity.

A monopsonist reaches a different outcome. Because the extra cost of buying more rises faster than the supply price, the buyer stops earlier. It buys a lower quantity than a competitive market would trade, and the price paid to suppliers is also lower than the competitive price. In the example from the table, competitive buying would trade every unit worth at least its supply price: 4 units at GBP13. The monopsonist buys 3 units at GBP12.

This creates allocative inefficiency. Some units that would have been traded competitively are no longer bought, even though suppliers could have provided them and the buyer still valued them. In other words, monopsony creates under-trading: fewer mutually beneficial exchanges take place.

It also redistributes surplus. The buyer gains by transferring income away from suppliers through a lower buying price. Separately, there is a net welfare loss because some trades disappear altogether. In the example, paying GBP12 instead of GBP13 on 3 units moves GBP3 from suppliers to the buyer, while the lost fourth unit, worth GBP14 to the buyer and supplied at GBP13, is a GBP1 deadweight loss. That is why strong evaluation separates redistribution from deadweight loss rather than treating them as the same thing.