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February 17, 2018 

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LONG-RUN ADJUSTMENT: The combined adjustment of an industry and of each firm in the industry to an equilibrium condition that based on (1) profit maximization when all inputs are variable and (2) the entry and exit of firms. The complete adjustment is undertaken by both perfect competition and monopolistic competition. There are two parts of this adjustment process. One is the adjustment of each firm to the appropriate factory size that maximizes long-run profit. The other is the entry of firms into the industry or exit of firms out of the industry, to eliminated economic profits or economic losses. The end result of this long-run adjustment is different for the two market structures based on the fact that perfect competition has equality between price and marginal revenue, while monopolistic competition does not.

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MONOPSONY, EFFICIENCY:

A monopsony firm generally purchases less output and pays a lower price than would be the case for perfect competition. In particular, the factor price charged by a monopsony is less than the marginal revenue product. The key source of this inefficiency is market control, which means monopsony faces a positively-sloped supply curve and factor price is less than marginal factor cost.
Monopsony is a market in which a single buyer completely controls the demand for a good. While the market for any type of good, service, resource, or commodity could, in principle, function as monopsony, this form of market structure tends to be most pronounced for the exchange of factor services. Because it is the only buyer in the market, the supply curve it faces is the positively-sloped market supply curve. Any seller that seeks to sell, must sell to the monopsony.

Like any firm with market control, monopsony does not efficiently allocate resources. It violates the standard factor market efficiency criterion that factor price equal marginal revenue product. At the profit-maximizing quantity purchased by a monopsony, factor price is less than marginal revenue product.

The reason for monopsony inefficiency is found with market control. Because the monopsony firm IS the market, the market supply curve is THE supply curve for the monopsony's purchases. Because the supply curve is positively sloped, factor price is less than marginal factor cost. And because a profit maximizing firm equates marginal revenue product with marginal factor cost, the factor price paid by monopsony when it maximizes profit is less than marginal revenue product.

Profit Maximization

Inefficiency
Inefficiency
To illustrate the inefficiency of monopsony consider the Natural Ned Lumber Company, a hypothetical lumbering operation in the isolated Jagged Mountains region north of the greater Shady Valley metropolitan area. The Natural Ned Lumber Company is the only employer of labor located in nearby Lumber Town. This makes the Natural Ned Lumber Company a monopsony employer and a price maker when it comes to buying labor services from Lumber Town.

A typical profit-maximizing input hiring decision using the marginal revenue product and marginal factor cost is presented in this diagram. The three curves presented are the marginal revenue product curve (MRP), the market supply curve (S), and the corresponding marginal factor cost curve (MFC) for the monopsony.

A profit-maximizing monopsony produces the quantity of output that equates marginal revenue product with marginal factor cost, then pays the price sellers are willing and able to accept for that quantity. Natural Ned maximizes profit by hiring the number of workers that equates marginal revenue product and marginal factor cost, which is 37,000 workers in this example. The corresponding price paid is $8.40.

This profit-maximizing level of employment is not efficient. In particular, the factor price is $8.40, but the marginal revenue product is $13. Society is using labor to produce and consume a good that it values at $13 (marginal revenue product). However, in so doing, society is using resources that could have produced other goods valued at $8.40 (marginal factor cost). Society gives up $8.40 worth of value and receives $13.

This is a good thing. It is so good, that society should do more. However, the monopsony is not letting this happen. Natural Ned is not hiring as many labor resources that can be devoted to production as society would like.

An Efficient Alternative

The degree of monopsony inefficiency can be illustrated with a comparison to perfect competition. Such a comparison is easily accomplished by clicking the [Perfect Competition] button. A primary use of perfect competition is to provide a benchmark for the comparison with other market structures, such as monopsony.

A comparison between monopsony and perfect competition indicates:

  • Monopsony hires less input than perfect competition. In this example, the monopsony hires 37,000 workers compared to about 50,000 workers for perfect competition. The Natural Ned monopsony does not allocate enough resources to the production of lumber.

  • Monopsony pays a lower price than perfect competition. In this example, the monopsony price is $8.40 per worker versus about $10 worker for perfect competition. The Natural Ned monopsony is NOT efficient because it hires a quantity in which factor price is less than marginal revenue product.

<= MONOPSONYMONOPSONY, FACTOR MARKET ANALYSIS =>


Recommended Citation:

MONOPSONY, EFFICIENCY, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2018. [Accessed: February 17, 2018].


Check Out These Related Terms...

     | monopsony | monopsony, minimum wage | monopsony, factor market analysis | factor market, efficiency |


Or For A Little Background...

     | factor market analysis | marginal factor cost | marginal factor cost, monopsony | marginal revenue product | profit maximization | efficiency | market control | market structures | perfect competition |


And For Further Study...

     | perfect competition, factor market analysis | monopoly, factor market analysis | bilateral monopoly, factor market analysis | compensating wage differentials | oligopsony | monopsonistic competition | bilateral monopoly |


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