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

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

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.