Economics

15c. Profit-Maximization by a Monopsonist A monopsony is defined as the only buyer in a given input market. A monopsony, the sole buyer in an input market, is the mirror image of a monopoly, the sole seller in an output market. A monopsony exercise some control over the price paid for an input and faces an upward sloping supply curve. Like a competitive firm, a profit-maximizing monopsony will determine the appropriate level of input use where the marginal cost of labor (MFCL) intersects demand (MRPL) . However unlike a competitive firm, a monopsonist’s MFCL is not equal to its AFCL. This is due to the fact that since a monopsony confronts the entire input market demand curve by itself, in order to increase the number of workers it employs, it must raise the wage it pays to its workers. Fig. 2 illustrates why the marginal cost of an additional unit of input in a monopsony is greater than the average cost of that input (why the MFCL curve lies above the AFCL curve).Assume that each worker is capable of producing 1 hour of labor. Hiring one worker cost you $1 and you get 1 hour of labor; the MFCL is $1. If you want to you hire 2 workers, you can get 2 hours of labor at $2 a piece; the MFCL is $3 [ 2 x $2 - $1 (for 1 worker) = $3 ]. To you hire 3 workers, you get 3 hours of labor at $3 a piece; the MFCL is $5 [ 3 x $3 - $4 (for 2 workers) = $5 ]. Because the monopsonist the same wage to all its workers, to hire an additional worker, it must pay more to the workers it was already employing. So we see that a monopsonist’s MFCL is greater than its AFCL and that consequently the MFCL curve is steeper than the input supply curve. Fig. 2 P MFCL SL = AFCL Q 1 2 3 Fig. 3 demonstrates the welfare effects of a monopsony. In a competitive input market, the consumer surplus = areas a + b + c, the producer surplus = areas d + e + f, and there is no deadweight loss. In a monopsony, the consumer surplus (the surplus for the buyer of inputs, the monopsonist ) = areas a + b + d, the producer surplus (the worker’s surplus) = area f, and the deadweight loss = areas c + d. Fig. 3 P MFCL SL = AFCL D = MRPL Q Because it is the sole buyer of inputs in a given market (in this case, the labor market) a monopsonist is able to pay less than the competitive price for those inputs. The monopsony realizes a profit by paying the laborer a wage lower than the value of the marginal product (VMP) that the laborer is producing. In Fig. 4, we will examine the case of a simple monopsonist and in Fig. 5, we will look at the behavior of a monopsonist who is also posses monopoly power in its output market. In both case, the monopsonist will determine profit-maximizing input level where MFCL intersects demand (MRPL) and pay wage* for that quantity of input (L*). The simple monopsonist’s profit is designated by area a in Fig. 4. The profit realized by the monopsonist/monopolist is area a + b in Fig. 5. The size of either monopsonist’s profit depends on the elasticity of the input supply. Because the monopsonist in Fig. 5 is also a monopolist, his VMP curve is greater than his demand (MRPL) curve. Remember that a monopolist sets the price for its output above where marginal revenue intersect marginal cost. Since we know that for the monopsonist/monopolist p > MR and VMP = p x MPL and MRPL = MR x MPL, then it follow that for the monopsonist/monopolist VMP > MRPL. Given that the correct measure of a worker’s value is the value of marginal product of the output he produces, we can see that in both cases workers are being exploited because they are paid a w* < VMP. As long as there exists either monopoly market power in the output market or monopsony market power in the input market, there will be exploitation of labor. Fig. 4 P MFCL SL = AFCL D = MRPL = VMP Q L*