San José State University
Department of Economics
Thayer Watkins
Silicon Valley
& Tornado Alley

An Economic Welfare Analysis of
a Protected Monopsony

A monopsony is a firm which is the only purchaser of a good or service. A protected monopsony is a firm with a state protection of its monopsony status. For example, in Ghana under British control, the Ghana State Marketing Board was created and the cacao farmers were required by law to sell their produce only to that Board. The Marketing Board kept the price paid to farmers below the price at which cacao sold for in international markets. The difference in prices provided a substantial profit for the Marketing Board.

Monopsonies can also exist in labor markets. If a company is the only employer of labor in a labor market it is a monopsony, but it may not be a protected monopsony. If other firms are legally prevented from employing labor then the monopsony is a protected one. If other firms can employ labor in the market but choose not to do so then the first firm is a monopsony but not a protected monopsony.

A protected monopsony which is unregulated makes profit by restricting its purchases to lower the price of the good or service. It makes a profit but the gain in profit from monopsonization of a market is less than the cost to sellers as a result of the lower price. Therefore there is a net social loss from a protected monopsony.

Consider the following case. The commodity is supplied by a competitive industry. The supply side of the market is represented by the supply curve for the commodity. Each level of purchases for the monopsonists determines a level of revenue. From this relationship between the amount purchased and the level of revenue a marginal revenue (MR) curve can be constructed. This MR is plotted in the same diagram as the supply curve for the commodity. It is important to separate the profits and economic welfare loss due to the protected monopsony from whatever possible profits and economic welfare loss which may accrue to the firm from some monopoly position in the market it sells in. The MR curve makes no presumptions about the nature of that market.

The protected monopsonist takes into account the effect of additional purchases on the price of the commodity. The marginal cost of a purchase is therefore more than the price of the additional purchases. For a straight-line supply schedule the slope of the marginal cost curve is twice the slope of the supply schedule. The monopsonist chooses the level of purchases where the marginal cost curve intersects the marginal revenue curve. The purchase price for the commodity is the price that results in the supply of that level of the commodity.

The socially optimum output and price are given by the intersection of the supply schedule and the marginal revenue curve. Presuming no externality, the supply curve represents the marginal social cost curve so its intersection with the marginal revenue curve corresponds to the level of production and consumption such that marginal benefit is equal to marginal cost and both correspond to the market price. These are represented in the above graph by Qopt and Popt.

The monopsonist however maximizes its profits where its marginal cost is equal to marginal revenue. In the graph the level of output of the monopsonist is shown as Qm and the price the monopsonist establishes for its purchases is Pp. Although the monopsonist has a monopsony on the purchase of the commodity it does not necessarily have to market the commodity itself. It could get the amount Qm by offering the price Pp and then sell that quantity to marketers. The marketers would buy the commodity up to the point where the marginal revenue is equal to their purchase price. The marginal revenue curve becomes the demand curve for the marketers. Therefore if the monopsonist wants to sell a quantity Qm it would charge a price pm. The monopsony's profit would then be the difference between the price it sells the commodity for and the price at which it purchases it times the amount sold; i.e., monopsony profit equals (Pm-Pp)Qm.

The level of the monopsony profit can be compared with the loss to the consumers' (in this case called the consumers have been called the marketers) and the commodity producers' surplus, as is shown in the diagram below.

The loss to the consumers is the area of the pink-colored trapezoid. The loss in producers surplus to the commodity makers is the area of the lavender-colored trapezoid.

Now these losses can be compared with the level of monopsonistic profits.

The profit of the monopsonist is the green-shaded rectangle. Clearly the loss of consumer and producer surpluses is greater than the amount of the monopsony profit by the area of the triangles.

If the monopsonist does not purchase the quantity it sells but instead produces that amount itself then the lavender colored area is the profits the monopsonist would lose in functioning as a monopsonist rather than as a price-taking firm producing at the socially optimum level of production. Thus the net gain in profits for the monopsonist is the monopsony profits less the area of the lavender trapezoid.

The net loss of the economy due to the monopsony is the area of the pink and lavender trapezoid less the rectangle representing the monopsony profits. The result is the same as before; the net social loss due to the monopsony is the area of the two triangles.

It is very important to remember that the above analysis applies only to the protected monopsony; i.e., a firm who is protected by the State from competition. If there is a small town in which there is only a a single employing company despite freedom of entry then that company has a monopsony but it is not a protected monopsony. Even if that employer exploits its monopsony power there is no economic welfare loss due to monopsony. When the town grows enough it will get a second employer. It will get one when someone sees that the revenue it will generate exploiting all the opportunities for price discrimination will be greater than the cost. For the people of the town it is not a choice between perfect competition and monopsony it is a choice between mon-opsony and zero-opsony. The towns people are clearly better off with the exploitative monopsony than they were with no employer because they could ignore the existence of the single employer and continue to do whatever they did before it located there.

The above point harkens back to the French engineer, Jules Dupuit, who essentially founded cost benefit analysis. He asked when should a bridge be built in a particular location. His answer was that it should be built when the revenues that would be generated if the bridge were operated as a monopoly taking advantage of price discrimination exceeds the costs of building it. In building and operating it the costs may be reduced taking advantage of monopolistic advantages at the location. Dupuit did not assert that the bridge should actually be operated that way, he was only looking for a criterion about when or if the bridge should be built. However, any other mode of operation would require government subsidies financed out of taxes which would involve a transfer of welfare from one segment of the economy to another.

On this matter of poossible welfare losses due to competition deemed not to be perfect the Austrian School of Economics deviates sharply from the Neoclassical School. Clearly in this matter the Austrian School is correct; freedom of entry and exit is the essential criterion of competitiveness.

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