Download Profit-Maximization by a Monopsonist

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 MFC L 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
$5
SL = AFCL
$3
$2
$1
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
a
SL = AFCL
b
c
d
d
f
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 MP L
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
exploitation
a
W*
D = MRPL = VMP
Q
L*