Encyclonomic WEB*pedia: MONOPSONY, FACTOR MARKET ANALYSIS

MONOPSONY, FACTOR MARKET ANALYSIS:
The analysis of a factor market characterized by monopsony indicates that the single buyer maximizes profit by equating marginal revenue product to marginal factor cost. This results in a lower price and smaller quantity than achieved with perfect competition. As such, it does not achieve an efficient allocation of resources. Monopsony is combined with monopoly to form a bilateral monopoly market structure.
Monopsony is a market dominated by a single firm buying the product. Monopsony is the buying-side equivalent of a selling-side monopoly. Much as a monopoly is the only seller in a market, monopsony is the only buyer. While monopsony can be analyzed for any type of market, it tends to be most relevant for factor markets in which a single firm does all of the buying of a factor of production.
Comparable to a monopoly seller, a monopsony buyer is a price maker with complete market control on the buying side of the market. Monopsony is also comparable to monopoly in terms of inefficiency. Monopsony does not generate an efficient allocation of resources. The price paid by a monopsony is lower and the quantity exchanged is less than would be had by perfect competition.
Monopsony Cost and Revenue
An example that can illustrate a monopsony factor market is provided by the Natural Ned Lumber Company. This is a hypothetical lumbering operation in the isolated Jagged Mountains region north of the greater Shady Valley metropolitan area. The Natural Ned Lumber Company is an expansive operation employing thousands of workers, all of whom reside in Lumber Town, which is adjacent to the Natural Ned Lumber Company lumbering operations. In fact, everyone living in Lumber Town works for the Natural Ned Lumber Company.
This makes the Natural Ned Lumber Company a monopsony employer. If anyone in Lumber Town seeks employment, then they must seek it with the Natural Ned Lumber Company. This makes the Natural Ned Lumber Company a price maker when it comes to buying labor services. The Natural Ned Lumber Company can determine the quantity of labor services desired, then charge the minimum factor price that workers are willing and able to receive.
Ned's Lumber Employment

This diagram displays the market for labor services in Lumber Town. The vertical axis measures the factor price (wage rate) and the horizontal axis measures the quantity of labor services (number of workers). The key for any monopsony buyer like the Natural Ned Lumber Company, is that the supply curve it faces for hiring labor is THE market supply curve for the factor.
Supply: To identify the labor supply curve facing the Natural Ned Lumber Company, click the [Supply]. The resulting curve, labeled S, is positively sloped, indicating that workers require a higher wage to increase the quantity supplied. More to the point, if Natural Ned wants to hire more workers, it must pay a higher wage. This supply curve is also the average factor cost curve for Natural Ned.

Marginal Factor Cost: Because Natural Ned pays a higher wage (average factor cost) to hire more workers, marginal factor cost is greater than average factor cost at each level of employment. Marginal factor cost is the key bit of information Natural Ned needs to hire the profit maximizing number of workers. To identify the marginal factor cost curve, click the [Marginal Factor Cost] button. The revealed curve, labeled MFC, is also positively sloped and lies above the supply (average factor cost) curve.

Marginal Revenue Product: The other half of Natural Ned's profit-maximizing decision is marginal revenue product. Marginal revenue product indicates the change in revenue resulting from hiring one additional worker. A click of the [Marginal Revenue Product] button reveals Natural Ned's marginal revenue product curve, labeled MRP. This curve is negatively-sloped because marginal revenue product is based on marginal physical product which declines with extra employment due to of the law of diminishing marginal returns. Because each additional worker is less productive, each additional worker generates less extra revenue.
Profit Maximizing Employment
All of the information needed to identify the quantity of workers that maximizes Natural Ned's profit is in hand. The profit-maximizing employment is the quantity that equates marginal factor cost and marginal revenue product, which is the intersection of the MFC and MRP curves. Click the [Profit Max] button to highlight this quantity. The profit-maximizing quantity of employment is 37,000 workers.
Why is this profit maximization?
Should Natural Ned hire fewer than 37,000 workers, then marginal revenue product is greater than marginal factor cost. An extra worker contributes more to revenue than it adds to cost. This increases Natural Ned's profit. Natural Ned should hire any worker with a marginal revenue product that exceeds marginal factor cost.

Should Natural Ned hire more than 37,000 workers, then marginal revenue product is less than marginal factor cost. An extra worker contributes less to revenue than it adds to cost. This decreases Natural Ned's profit. Natural Ned should fire any worker with a marginal revenue product that is less than marginal factor cost.

Should Natural Ned hire exactly 37,000 workers, then marginal revenue product is equal to marginal factor cost. The last worker hired contributes as much to revenue as to cost. This keeps Natural Ned's profit constant. Natural Ned should hire workers up to the point that marginal revenue product is equal to marginal factor cost, but no more.
Once Natural Ned identifies the profit-maximizing employment, the final step is to determine how much to pay each worker. This information is found on the market supply curve (S). According to the market supply, a wage of $8.40 is sufficient to entice 37,000 workers to supply their labor services. Because Natural Ned is a monopsony, it needs to pay no more than this wage.
(In)Efficiency
As a profit-maximizing monopsony with market control, the Natural Ned Lumber Company does not achieve an efficient allocation of resources. This results because marginal revenue product is not equal to the factor price. While the Natural Ned Lumber Company pays a factor price of $8.40 per hour, marginal revenue product is $13 per hour.
This difference between factor price and marginal revenue product is a prime indicator of inefficiency. Marginal revenue product is the value of the good produced. Factor price is the opportunity cost of production, the value of goods not produced. If the two are equal, then the value of the good produced is equal to the value of goods not produced. Society cannot generate more overall satisfaction by producing more or less of the good.
However, for a monopsony like Natural Ned, marginal revenue product is greater than factor price. In this case, the value of the good produced is greater than the value of goods not produced. Society can generate more overall satisfaction by producing more of the good.
Because profit maximization means marginal revenue product is equal to marginal factor cost, and because marginal factor cost is greater than factor price, marginal revenue product is also greater than factor price for monopsony. A profit-maximizing monopsony does not, will not, cannot, efficiently allocate resources.
Check Out These Related Terms...
     | factor market analysis | perfect competition, factor market analysis | monopoly, factor market analysis | bilateral monopoly, factor market analysis |
Or For A Little Background...
     | monopsony | factor demand | factor supply | marginal revenue product | marginal factor cost | profit maximization | efficiency |
And For Further Study...
     | factor market, efficiency | monopsony, efficiency | monopsony, minimum wage | compensating wage differentials | perfect competition, short-run production analysis |
Recommended Citation:
     MONOPSONY, FACTOR MARKET ANALYSIS, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2025. [Accessed: December 16, 2025].