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A Note on Monopsony and ‘Monopsonistic Competition’

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Warning: wonky.

Pondering my post from earlier today on monopsony and monopoly [2], I believe that a further distinction is warranted.  It’s a distinction that I did not make in that post (because I didn’t then realize its relevance).  The distinction is between, on one hand, monopsony created by government-imposed restrictions on the purchase or hiring of certain inputs and, on the other hand, monopsony power that allegedly comes not from government-imposed restrictions but instead from “frictions” that cause each monopsonist to face an upward-sloping supply curve of the input.*

The distinction that I’ll draw runs parallel to the distinction between, on one hand, monopoly power in output markets that comes from government-imposed restrictions on the sale of certain outputs (e.g., only Darcy can legally sell playing cards) and, on the other hand, monopoly power that allegedly comes not from government-imposed restrictions but instead from “frictions” that cause each monopolist to face a downward-sloping demand curve for the output.  That is, the distinction that I’ll draw parallels that of the distinction between “pure monopoly” and “monopolistic competition.”

If a producer of Y enjoys a government-created and enforced privilege to be the sole buyer of input X (used by this firm to produce Y), this monopsonist will, each period, purchase fewer units of X than it would purchase if it faced more competition to buy X, and pay a price for each unit of X that is below the price it would pay for X in the face of more competition to buy X.**  This outcome in the input market yields to this monopsonist excess profits on the employment of each but the very last unit of this input of X that it uses.  Even if this monopsonist faces competition in the output market for Y, there’s no reason to believe that all of these excess profits will be competed away.  The extent to which such profits are competed away depends on how much of a cost advantage this monopsonist has, because of its monopsony in X, over its rivals in the output market for Y.  The larger is its monopsony-enabled cost advantage over its rivals, the greater the excess profits it continues to enjoy from its monopsony privilege.  In this case, an appropriately set minimum-price (such as a minimum wage) could cause this monopsonist to increase both the quantity of X that it buys and the price that it pays for each unit of X.  But I emphasize that this outcome depends not only on Y having a government-granted privilege to be the sole buyer of X, but also on X being an input the use of which gives its user (Y) a cost advantage over all rivals (who are not permitted to buy X).

(It would be an interesting exercise, at this point, to trace through the consequences of such a minimum-price regulation on the total output of the Y industry as a whole.  But no such exercise need here be undertaken given that all I’m concerned with is what happens in the market for input X.  Again, we see that it’s possible for minimum-price regulation to increase both the amount of X bought and the price paid per unit of X when a monopsonist selling output in industry Y has a government-granted privilege to be the only buyer of input X.)

But the situation is entirely different if the monopsony over X is not the consequence of a government grant of exclusive privilege to buy X but, instead, is the result only of “frictions” that cause buyers of X to face upward-sloping supply curves of X.  If firms a, b, and c are all buyers of X, and if firms d, ef, … n are legally permitted to become buyers of X, then the conclusion of my letter to the Wall Street Journal holds: although each of these buyers and potential buyers of X faces an upward-sloping supply curve of X, unless these firms enjoy monopoly power in their output markets, even an ideally set minimum price of X will result in fewer units of X being bought.  Some units of X will, in short, be rendered unemployed by minimum-price regulation.

Here’s my reasoning that leads to this conclusion – reasoning that, as I explain it here, will reveal why I felt the need to write this long and wonky blog post:

Acme Corp. is a buyer of X that sells in a competitive output market and whose monopsony power over X is the result merely of “frictions” rather than of a government grant of exclusive privilege to buy X.  It might well be that the excess profits that Acme earns from its ‘frictional monopsony power’ over X give Acme no incentive to cut its output prices.  Presumably Acme is, for each of its inputs (including X), buying that quantity beyond which any additional purchases would add more to Acme’s costs than it would add to Acme’s revenues.

But Acme’s excess profits are chum in the competitive waters for other firms who can enter Acme’s output market and who are legally allowed to compete to buy input X.  Acme’s excess profits mean that output in the market in which Acme sells is currently too low.  New firms enter Acme’s output market.  These new rivals also compete with Acme in the market for input X; these new firms also buy and employ input X to produce their new outputs – new outputs sold in competition with that of Acme.  So even if by some miracle these additional buyers of X cause neither the market price of X to rise nor Acme to change the amount that it buys of X or the price that it pays for X, the price of Acme’s output falls.  Indeed, this competition in the output market will cause the price of Acme’s output to fall until Acme earns no further excess profits through its use of input X.

Therefore, in such a market a minimum-price-of-X mandate will, by pushing Acme’s total costs above its total revenues, cause Acme either to go out of business or to reduce the amount of output it produces.  (It’s perhaps easier to imagine a competitive output market – that is, a market with freedom of entry – full of Acmes that each use input X.  A minimum-price-of-X mandate will cause some of these firms to exit the industry until total industry output falls to such a level that allows the price of this industry’s output to generate revenues that just cover the remaining firms’ costs.)

……

* Here’s Furman and Krueger [3]:

[N]early all employment arrangements involve a degree of implicit monopsony power: Frictions, such as finding new child-care arrangements or spending time searching for work, can make it costly for workers to change jobs. Many companies exercise monopsony power even though they are not the only employer in town.

** For simplicity, I here assume that the monopsonist doesn’t price-discriminate in its purchase of input X.

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