Where is the monopsony power?

You hear it claimed relatively often today that low wage employers have monopsony power. For example, this is a sometimes cited explanation for the claim that there is no disemployment effect of the minimum wage. A monopsony is when an employer has market power in the labor market, sort of the employer equivalent of a monopoly. The argument is that a monopsonist is able to hold wage below the equilibrium level, just like a monopolist would hold prices below the competitive equilibrium. Economic theory suggests that in response to a price floor that increases prices slightly, a monopsonist might not decrease labor demand. However, a recent study provides empirical evidence that seems somewhat at odds with this: large retailers pay more than small retailers.

You can find more about the study here, I'll quote myself summarizing the results:

The researchers found some starting facts. For instance, after controlling for individual and store characteristics, firms with at least 1,000 employees pay 9% to 11% more than those employing 10 or fewer. Looking at individual establishments rather than firms, large stores pay 19% to 28% more than small ones. This is consistent with research in non-retail industries that finds, all else equal, big firms tend to pay more. In addition, they find that retail managers make more per hour than non-managers in manufacturing, and that there are more managers in retail than in manufacturing.

So this raises something of a puzzle to me. If monopsony power is an important feature of the labor market, and monopsony power should be prevalent when firms are bigger and therefore have a larger share of the local industry, then why do big firms pay more than small firms? The small mom and pops should be closest to operating in a competitive labor market and have little bargaining power, but they pay less. Maybe the productivity effects of big retailer outweigh the monopsony effect, but that just is another way of saying it's not as an important feature of the market. In addition, ask yourself whether you predicted this result of big firms paying more before you read about this study. Be honest, if someone asked you to predict the results, would you have told a story about big firms bargaining workers down to lower wages? If so, it is time to re-evaluate your views.

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MONOPOLY BOMBE 2006 (Photo credit: CHRISTOPHER DOMBRES)

More for the CALLMER people

The special case of the monopsonist is an important one.  A monopsonist is a single buyer of labour, such as De Beers, the diamond producer, and the major employer of diamond workers in South Africa. Monopsonists are common in some small towns, where only one large firm provides the majority of employment.

Because of their buying power, monopsonists are able to influence the price they pay compared with buyers in more competitive markets. Pure monopsonists are rare because suppliers normally have alternative outlets for their good or service. However, monopsony power is significant in certain sectors of the economy.

Two areas are worthy of mention, including the monopsony power of the large supermarkets, who can dictate terms to smaller suppliers, and the monopsony power associated with buyers of labour in the labour market.

In the case of supermarkets, as with other dominant buyers, the price paid to suppliers is often forced down so that the supermarkets can reduce costs and generate higher profits. Alternatively they can reduce their prices, assuming  they operate a cost plus pricing strategy.  In turn this can threaten rival suppliers, so increasing the monopsony power of the major supermarkets. In an increasingly globalised world the supermarkets are free to source supplies from around the world, thus making it difficult for smaller suppliers to compete.

In the case of single buyers of labour, a similar pattern can be found. Large employers, like the NHS and the Post Office, have the potential power to determine the wage rate, but the rise of labour unions has acted as a counterweight to the power of the monopolistic employer. In addition, NHS and Post Office workers have the freedom to seek work in other industries, or with other service providers. 

The monsopsonist, wages and employment

Because the monopsonist is the only employer in the industry, if it wishes to employ more labour it must raise the marginal wage to attract new workers into the industry. The supply curve of labour is not the same as the marginal costs of labour because, as the only employer, the monopsonist must pay all existing workers the same rate as the new workers. Hence, when attracting new workers, the marginal cost of labour is greater than the existing average cost of labour.

This can be illustrated with the example of a hair salon in a small town.

Workers	Wage to attract new workers	Total cost of labour	Marginal cost of labour	Marginal revenue product
1	10	10		70
2	20	20 + 20 = 40	30	60
3	30	30 + 30 + 30 = 90	50	50
4	40	160	70	40
5	50	250	90	30
6	60	360	110	20
7	70	490	130	10
8	80	640	150	0

The monopsonist's marginal cost of labour and supply curve

However, the individual wage paid to the workers is only £30. In this case, the monopsonists is said to be exploiting the workers by paying less than the MRP – i.e. wages are £30 per hour, and the MRP is £50 per hour, meaning that the monopsonist has gained £20. It can achieve this because it does not have to pay the full value of the MRP.

Assuming the monopsonist tries to maximise profits, it will demand labour up to the point where MCL = MRP. This will occur at 3 hairdressers, where the MCL and MRP are both £50 per hour, as shown below:

However, if there are several hair salons in the town, each salon will have to bid up the wage rate in order to attract sufficient hairdressers so that they can maximise their individual profits. The competitive wage rate would exist where the wage to attract workers (the labour supply curve) equals the MRP curve, at a rate of £40, and employing 4 hairdressers.

What if a union fixes a minimum wage?

A union minimum wage

A union can represent workers and seek to increase the benefits to workers. For example, what would happen if the union of hairdressers sets a minimum wage at £40, the competitive rate?

If a trade union enters the labour market and becomes the monopoly supplier of labour, it can force the monopsonist to pay a wage at, or nearer to, the market rate, and employ more workers.  At a minimum wage of £40, the supply of labour is horizontal at this wage, with the MCL = ACL (S), and the profit maximising monopsonist would employ up to the point where the MCL = MRP, which is at 4 workers  - i.e. the market wage rate and the market level of employment.

However, if the minimum wage is set above £40, demand will contract and fewer will be employed. For example, setting the wage at £60 would mean only 2 hairdressers are employed.

The impact of the union minimum wage

The effect of the minimum wage clearly depends upon its level, and whether it is set above the market rate - the greater it is above the competitive market rate, the lower the level of employment.

The impact of the union minimum wage also depends on the elasticity of demand and supply of labour. For example, if the demand for labour is relatively inelastic, jobs lost due to the minimum wage will be relatively small. Similarly, if supply is inelastic, the minimum rate may not result in a significant change in employment

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Especially for the CALLMER people!

Monopsony power from tutor2u

Labour market and monopsony

Labour Market Economics Revision Notes from tutor2u

Monopsony Power

Definition of Monopsony. A monopsony occurs when a firm has market power in employing factors of production. A monopsony means there is one buyer and many sellers. This is a similar concept to monopoly where there is one seller and many buyers.

What is monopsony power?

• A monopsony has buying or bargaining power in their market.
• This buying power means that a monopsony can exploit their bargaining power with a supplier to negotiate lower prices.
• The reduced cost of purchasing inputs increases their profit margins
• Monopsony exists in both product and labour markets – in this chapter we focus on buying power in the markets for goods and services

Evaluating the economic welfare effects of monopsony power in markets

In evaluation it is important to remember some of the possible advantages from monopsony power:

1. Improved value for money – for example the UK national health service can use its bargaining power to drive down the prices of routine drugs used in NHS treatments and ultimately this means that cost savings allow for more treatments within the NHS budget.
2. Producer surplus has a value as well as consumer surplus – lower input costs will raise profitability that might be used to fund capital investment and research.
3. A monopsony can act as a useful counter-weight to the selling power of a monopolist e.g. the NHS versus the global pharmaceutical companies.
4. In most supply chain relationships – for example between supermarkets and their suppliers – the long term sustainability of an industry requires that both benefit – if there are no mutually beneficial gains from trade, ultimately trade and exchange will break down.
5. The growth of the Fair Trade label and organisation is evidence of how pressure from consumers can lead to improved contracts and prices for farmers in developing countries. For example if tea producers in Rwanda get a stronger price for their output, the increased income and profit will have important economic and social benefits for the exporting industry and the wider economy.

Key evaluation point - it is often difficult to assess the strength of monopsony power

RyanAir to buy 175 new aircraft

Low-fare airline RyanAir is to buy nearly £10 billion-worth of new planes in a move that will create more than 3,000 jobs. The no-frills Irish carrier is purchasing 175 of Boeing's new 737-800 aircraft, which will be delivered over the period up to 2019. The new planes will allow RyanAir to grow its fleet to more than 400 aircraft, serving more than 100 million passengers a year across Europe by 2019.Source: News reports, June 2013

Source: Tutor2u

Monopsony in the Real World

There are several employers who might employ supermarket checkout workers. However, in practise, it is difficult for workers to switch jobs to take advantage of higher wages. There is a lack of information and barriers to moving jobs. Therefore, although there are several buyers of labour, in practise they have a degree of monopsony power.

Problems of Monopsony in Labour Markets

• Monopsony can lead to lower wages for workers. This increases inequality in society.
• Workers are paid less than their marginal revenue product.
• Firms with monopsony power often have a degree of monopoly selling power. This enables them to make high profits at the expense of consumers and workers.
• Firms with monopsony power may also care less about working conditions because workers don’t have many alternatives to the main firm.

Monopsony in Product Markets

In several industries there is one buyer and several sellers.

• Supermarkets have monopsony power in buying food from farmers. If farmers don’t sell to the big supermarkets, there are few alternatives.
• Amazon.com is one of the biggest purchases of books. If publishers don’t sell to Amazon at a discounted price, they will miss out on selling to the biggest distributor of books.

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