Tag Archives: Monopsony – Labour Market

Monopsony v Monopoly – Tesco v Unilever

Geoff Riley did a very good post on Tutor2u that outlined the recent dispute between Tesco and Unilever. Marmite, PG Tips tea and Pot Noodles are among dozens of brands currently unavailable on Tesco’s online site due to this dispute with Unilever. Unilever raised its price by 10% in the UK to compensate for the sharp drop in the pound’s value.

Tesco is resisting the move and has removed Unilever products from its website. Unilever see the price increase as a  “normal” reaction to shifts in currency values – since the Brexit vote there has been a 17% decrease in the value of the pound which has added to the cost of importing goods. The products currently absent from Tesco’s website also include Comfort fabric conditioner, Hellmann’s mayonnaise and Ben & Jerry’s ice cream. With the A2 exam looming here are some notes on Monopoly and Monopsony.

Monopoly and Monopsony theory

Monopoly. Perfect competition is not to be found in the real world and absolute or pure monopoly is also virtually impossible to achieve since it applies operating in the absence of competition (i.e. no substitutes). While it is not difficult for a firm to become a sole supplier it is extremely difficult to achieve a situation where there are no substitutes for the product. A more realistic definition of monopoly would be ‘a sole supplier of a commodity for which there are no good substitutes’. In fact the degree of monopoly power in the real world tends to be judged on the basis of the share of the total market accounted for by any particular supplier.

The graph below shows that at profit maximising equilibrium, output Qm is less than that in a competitive market (Qe), and the demand and supply (MC) curves do not intersect. Qe represents the Allocative Efficiency level of output and Pe the price. The shaded area therefore represents the loss of allocative efficiency or the deadweight loss.

monopoly-dwl 

Therefore monopolists restrict output and mis-allocate resources leading to a deadweight loss to the economy. However the government, using price controls, can force a shift from the preferred monopoly equilibrium (MC=MR) to one equivalent to the perfectly competitive equilibrium (MC=AR). At the less-preferred equilibrium, a monopolist’s supernormal profit may be either reduced or turned into a subnormal profit. In the latter case, a permanent subsidy may be necessary to keep the firm in business.

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

A monopsony occurs in the labour market when there is a single or dominant buyer of labour. The buyer therefore is able to determine the price at which is paid for services. Unlike other examples we have looked at, in this situation we are now dealing with an imperfect rather than a perfectly competitive market. The monopsonist will hire workers where:

monopsony-labour

Marginal Cost of labour (MCL) = Marginal Revenue product of labour (MRPL)

You will remember from the notes on the Perfect Labour Market that this is known as the profit maximising position.

From the perspective of the monopsonist firm facing the supply curve directly, if at any point it wants to hire more labour, it has to offer a higher wage to encourage more workers to join the market – after all, this is what the ACL curve tells it. However, the firm would then have to pay that higher wage to all its workers so the marginal cost of hiring the extra worker is not just the wage paid to that worker, but the increased wage paid to all workers as well. So the marginal cost of labour curve (MCL) can be added to the diagram.

If the monopsonist firm wants to maximise profit, it will hire labour up to the point where the marginal cost of labour is equal to the marginal revenue product of labour. Therefore it will use labour up to level of Eq which is where MCL=MRPL. In order to entice workers to supply this amount of labour, the firm need pay only the wage Wq. (Remember that ACL is the supply of labour). You can see, therefore, that a profit-maximising monopsonist will use less labour, and pay a lower wage, than a firm operating under perfect competition.

In this situation the power of the employer in the labour market is of overriding importance and the employer can set a low wage because of this buying power.

Monopsony power in the labour market and the minimum wage

Min Wage 2011In 1894 New Zealand made history by being the first developed nation to introduce a minimum wage. The Economist had an article on minimum wages and the fact that they might in fact be good for an economy. Most economists believe that a higher minimum wages = the artificial increase in labour costs and therefore lower demand for labour.

Some economists have suggested that minimum wages can increase employment and obviously pay. However if employees have monopsony power as buyers of labour and are able to influence wages they can keep the wages lower below its competitive rate – see graph below.

Two economists (David Carr & Kruegger) found out in New Jersey that when the minimum wage was raised employment in fast-food restaurants actually increased. The Economist suggests that if firms are not reducing the number of their employees with higher minimum wages they must be employing a number of strategies such as raising prices of their goods/services or saving money from reduced revenue. The IMF state that a moderate minimum wage (30-40% of the median wage – see graph) doesn’t have a significant negative effect on employment numbers and may do some good.

Monopsony in the Labour Market

Monopsony Lab

A monopsony occurs in the labour market when there is a single or dominant buyer of labour. The buyer therefore is able to determine the price at which is paid for services. Unlike other examples we have looked at, in this situation we are now dealing with an imperfect rather than a perfectly competitive market. The monopsonist will hire workers where:

Marginal Cost of labour (MCL) = Marginal Revenue product of labour (MRPL)

From the perspective of the monopsonist firm facing the supply curve directly, if at any point it wants to hire more labour, it has to offer a higher wage to encourage more workers to join the market – after all, this is what the ACL curve tells it. However, the firm would then have to pay that higher wage to all its workers so the marginal cost of hiring the extra worker is not just the wage paid to that worker, but the increased wage paid to all workers as well. So the marginal cost of labour curve (MCL) can be added to the diagram.

If the monopsonist firm wants to maximise profit, it will hire labour up to the point where the marginal cost of labour is equal to the marginal revenue product of labour. Therefore it will use labour up to level of Eq which is where MCL=MRPL. In order to entice workers to supply this amount of labour, the firm need pay only the wage Wq. (Remember that ACL is the supply of labour). You can see, therefore, that a profit-maximising monopsonist will use less labour, and pay a lower wage, than a firm operating under perfect competition.

In this situation the power of the employer in the labour market is of overriding importance and the employer can set a low wage because of this buying power.