Question

Show using a graph that if a monopolist in an input market faces a monopsonist in the same input market, the equilibrium level of input use is indeterminate.

Answer 1

Assumptions:-

1. The monopolist is its sole producer or seller.
2. The monopolist is its only buyer.
3. There is a single commodity with no close substitutes.
4. The monopolist and the monopolist are both free to maximise their own individual profits.

Through given figure it can be expalined that equilibrium price cannot be obtained but range can be given of equlibrium price which depends upon the bargaining power of both the parties.

The equilibrium of the producer- monopolist is defined by the intersection of his marginal revenue and marginal cost curves at point A. For maximize his profit he will sell X1 quantity at P1 price level. As there is only one buyer, the buyer can affect the price of the monopolist.

For monopsonist, MC is the supply curve with upward sloping as the monopsonist increases his purchases the price he will have to pay rises. ME is the marginal cost of equipment for the monopsonist-buyer (his marginal outlay or marginal expenditure). The equipment is an input for the buyer.The equilibrium of the buyer- monopsonist is defined by the intersection of his ME and demand curve(D) at point R. For maximize his profit he will buy X2 quantity at P2 price level.

Given that the buyer wants to pay P2 while the seller wants to charge P1, there is indeterminacy in the market. sooner or later start negotiations and will eventually reach an agreement about price, which will be settled somewhere in the range between P1 and P2, (P2<=P*<=P1),with quantity X* at point B de­pending on the bargaining skill and power of the firms.