Monopsony

Monopsony is the “flip side” of monopoly. In monopoly, a firm is the sole seller of product to a group of consumers. Thus, the monopolist faces a downward sloping demand curve for its product. Every unit of output the firm produces reduces the market price for its good. This implies that the more goods the monopolist sells, the lower the monopolist's price. This in turn implies that selling an additional unit may be costly to the monopolist, and possibly result in a reduction of revenue at the margin (or “marginal revenue”) to the monopolist. Thus, a monopolist will set output so that price is higher and quantity lower than the competitive outcome. This, in turn, creates deadweight loss, as not all the goods that could increase welfare in society will be sold.

In contrast, a monopsonist is the sole buyer of a particular input that it uses. For example, assume that trees are difficult to ship relative to milled wood. The only lumber mill in a geographic region might well have monopsony power over the foresters in this region. A monopsonist may well (and often does) face a perhaps perfectly elastic demand for its product in the outside world. But its market power over the relevant input that it purchases is similar to the power that a monopolist holds over the product that it monopolizes, as well as the deadweight loss generated by that market power.

Given this situation, what determines how much product (here trees) the miller will choose to purchase? Every tree the miller purchases raises the market price of trees. So purchasing one tree involves not only an additional payment to the owner of that tree but also more payments to the owners of other trees who sell to the monopsonist miller. So the miller will purchase trees so that the marginal cost of the purchase (which is above the market price) equals the marginal return, which (absent production costs) will equal the market price of milled wood from a particular tree in the “outside” market. As with the exercise of monopoly power, the exercise of monopsony power will reduce social welfare, as not all the inputs that could increase welfare in society will be sold.

Note that this story depends critically on a local input that has two conditions. First, there must be an upward sloping supply curve for the input. In other words, there needs to be an economic rent attached to the inputs used. Without this condition, there is no need to restrict purchases to stop the price of the product from rising. If the supply curve is perfectly elastic (“flat”), the monopsonist can have all the product it wants at the opportunity cost of the suppliers. Second, the input has to be more costly to transport in its “unfinished” state than in its “processed” state. Otherwise, the input suppliers could use transportation to reach downstream markets just as easily as the monopsonist.

By itself, monopsony does not violate Milton Friedman's ethical dictate that a firm should maximize its profits, subject to the rules of its society. At least in the United States, a “naturally occurring” monopoly (or monopsony) is not against the law. Broader ethical concerns can arise, however, from the monopsonist's ability to hold input prices below the competitive level. This monopsony harms the input suppliers, who are often small stakeholders in the relevant resource (say, forestry), to the benefit of the monopsonist, who is often a large corporation.

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