Intermediatemicroeconomics
Monopsony: When There Is Only One Buyer
Overview
A monopsony is a market with a single buyer — the mirror image of a monopoly. The classic case is a single employer in a company town, but modern examples include dominant local employers, hospital systems hiring nurses, and the government buying specialized defense equipment. A monopsonist faces the upward-sloping market supply curve and hires where marginal factor cost equals marginal revenue product, paying a wage below the value workers create. This lesson explains monopsony pricing, its welfare effects, and the surprising result that minimum wages can raise employment under monopsony.
Learning objectives
- Define monopsony and distinguish it from monopoly
- Derive why marginal factor cost exceeds the wage (supply price) for a monopsonist
- Find the monopsony equilibrium: MFC = MRP, wage read off the supply curve
- Explain the welfare loss from monopsony and the concept of employer exploitation
- Show why a minimum wage can increase employment under monopsony
Monopsony: monopoly in reverse
A monopsony is a market with one buyer and many sellers. Just as a monopolist restricts output to raise price, a monopsonist restricts purchases to lower the price it pays. The most-studied case is the labor market: a single employer — a mine in a remote town, a hospital system dominating local nursing jobs, a meatpacking plant in a rural county — faces many workers competing to sell their labor.
Monopsony power also appears outside labor. The US Department of Defense is effectively the sole buyer of fighter jets; a single supermarket chain may dominate purchases from local farmers. In each case, the buyer's size relative to the market lets it push the input price below the competitive level by buying less.
Marginal factor cost vs. the supply curve
The key analytical step mirrors monopoly. A competitive employer takes the wage as given, but a monopsonist faces the upward-sloping market supply curve: hiring one more worker requires raising the wage — and, crucially, raising it for all existing workers too, not just the new hire. The marginal factor cost (MFC) of the extra worker is therefore the new wage plus the increase paid to everyone already employed.
So MFC lies above the labor supply curve, just as marginal revenue lies below the demand curve for a monopolist. Example: if hiring the 10th worker requires raising the wage from 21 for all 10 workers, the MFC of that worker is 1 = 21 wage. This wedge between what the last worker costs at the margin and what workers are paid is the source of monopsony power.
The monopsony equilibrium: MFC = MRP
The monopsonist hires workers up to the point where marginal factor cost equals marginal revenue product (MFC = MRP) — the input-market analogue of MR = MC. But the wage it actually pays is not the MFC; it pays the lowest wage that attracts that many workers, read off the labor supply curve below the MFC curve.
The result: employment is lower and the wage is lower than in a competitive labor market. Workers are paid less than their marginal revenue product — the gap economists call monopsonistic exploitation (a technical term, not a moral accusation). Graphically, the outcome mirrors monopoly: a quantity restriction that creates deadweight loss, this time from too little employment rather than too little output.
Welfare effects and 'exploitation'
In the competitive benchmark, workers are hired until the value of the marginal worker's output (MRP) equals the wage, maximizing total surplus. The monopsonist stops earlier, where MFC = MRP, leaving mutually beneficial hires unmade: workers willing to work for more than their opportunity cost but less than their MRP go unhired. The deadweight loss triangle is the mirror image of monopoly's.
Joan Robinson, who developed the theory, used 'exploitation' to mean precisely this gap between wage and marginal revenue product — not underpayment relative to effort or fairness. Whether any particular wage gap reflects monopsony power or compensating differences in job quality is an empirical question, and modern labor economists test for monopsony using quit rates, wage responses to minimum wages, and employer concentration measures.
The minimum-wage surprise
Here is monopsony's most famous policy implication. In a competitive labor market, a binding minimum wage raises the wage but reduces employment — the standard textbook result. Under monopsony, a carefully set minimum wage can raise both wages and employment.
The logic: the minimum wage flattens the monopsonist's MFC curve at the minimum-wage level (each extra worker now costs exactly the minimum wage, with no need to raise anyone else's pay) up to the supply quantity at that wage. The firm then hires where this flat MFC meets MRP — more workers than before, at higher pay. Push the minimum wage too high, though, and employment falls again. This theoretical possibility motivated the famous Card and Krueger empirical studies finding small or zero employment losses from minimum-wage increases.
A minimum wage set between the monopsony wage and the competitive wage raises both pay and employment, because it removes the monopsonist's incentive to restrict hiring. Set above the competitive wage, it destroys jobs as usual.
Key points
- Monopsony = single buyer; the labor-market case is a dominant local employer
- MFC exceeds the wage because hiring more means raising pay for all existing workers
- Equilibrium: hire where MFC = MRP, but pay the wage on the supply curve
- Result: lower employment and wages than competition, with deadweight loss
- 'Exploitation' technically means wage below marginal revenue product
- A moderate minimum wage can raise both wages and employment under monopsony
Common misconceptions
✓ Truth: Monopsony is about market structure, not legality. A monopsonist can pay above the minimum wage yet still pay less than the competitive wage and less than workers' marginal revenue product.
✓ Truth: That holds in competitive labor markets. Under monopsony, a minimum wage between the monopsony and competitive wages increases employment by neutralizing the hiring-restriction incentive.
✓ Truth: It requires one (or a dominant) buyer in the relevant labor market — an occupation in a commuting zone, like nurses hired by one hospital system. Search frictions and limited mobility give many employers some monopsony power.
Practice questions
Q1. A monopsonist's marginal factor cost (MFC) exceeds the wage because:
- workers demand overtime premiums
- hiring an additional worker requires raising the wage paid to all existing workers
- the government taxes payrolls
- unions negotiate higher wages
Facing an upward-sloping supply curve, the monopsonist must raise the wage to attract one more worker and pay that higher wage to inframarginal workers too. MFC = new wage + raises for existing workers > wage.
Q2. The monopsony equilibrium hires labor where ____ and pays a wage read off ____.
- MFC = MRP; the labor supply curve
- wage = MRP; the MFC curve
- MFC = wage; the demand curve
- MRP = 0; the minimum wage
Profit maximization sets marginal factor cost equal to marginal revenue product for the hiring quantity, but the firm pays only the supply price needed to attract that many workers — below both MFC and MRP at that quantity.
Q3. Compared with a competitive labor market, monopsony results in:
- higher wages and higher employment
- lower wages and lower employment with deadweight loss
- higher wages and lower employment
- the same outcome
Restricting hiring to where MFC = MRP (rather than wage = MRP) lowers both employment and the wage, leaving mutually beneficial hires unmade — a deadweight loss triangle analogous to monopoly's.
Q4. A minimum wage set between the monopsony wage and the competitive wage will:
- reduce employment
- increase both the wage and employment
- leave the monopsonist unaffected
- bankrupt the employer
The minimum wage makes MFC flat (equal to the minimum) up to the supply quantity, removing the incentive to restrict hiring. The firm hires where flat MFC meets MRP — more workers at higher pay than the monopsony outcome.
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Frequently asked questions
What is the difference between monopsony and monopoly?
A monopoly is a single seller restricting output to raise the selling price; a monopsony is a single buyer restricting purchases to lower the input price. The analytics mirror each other: MR below demand becomes MFC above supply, and MR = MC becomes MFC = MRP.
Why is marginal factor cost above the supply curve?
Because the supply curve slopes upward, attracting an extra worker requires a higher wage — which must then be paid to all inframarginal workers too. MFC equals the new wage plus the raise given to existing workers, exceeding the wage itself.
Do real-world monopsonies exist?
Yes. Classic examples include company towns, hospital systems as the dominant nurse employer, and the NCAA's historical amateurism rules. Modern research finds many local labor markets are highly concentrated, giving employers measurable wage-setting power.
What is an oligopsony?
A market with a few large buyers — the buyer-side analogue of oligopoly. Meatpackers buying cattle or a handful of supermarket chains buying produce are typical examples, with strategic interaction among the buyers.