February 16, 2022 • 20 minute read
But who has the most
control over a specific price?
While it is true that particular areas within financial services (certainly not all) are prone to causing vast amounts of wealth to accumulate to a single seller, so too do other products. Railroads, pharmaceuticals, steel mills, computer operating systems, illegal drugs, telecommunications, and diamond mines to name a few. In those cases, it was many buyers acting on a high demand product but sold by a lone seller who then artificially restricted its quantity and thus increased its price—referred to as a monopoly—that caused the value to amass. It happened regardless of whether the product was a service that dealt in the lending of money or a tangible good like a gallon of oil.
And to expand our perspective, it is not always a lone seller who accumulates wealth in an ethically questionable manner. There is another phenomenon often overlooked. A lone buyer can artificially restrict the consumption and thus depress the price of other people’s services or goods that are in high supply. This is referred to as a monopsony. An example is an employer acting as a lone buyer of labor—either in an isolated town or a specialized industry—paying low wages to employees acting as many sellers. Coal mining towns are the classic example of a monopsony. Modern day farmers also find themselves in a similar predicament when selling their produce to a lone food processing facility.
Monopoly and monopsony are both a category of market.
Markets
A market is defined as any place and time where a trade occurs. An exchange can happen inside a store or even at a temporary stand located on a sidewalk. Trades can also take place virtually—online or over a phone. In a typical market a product is exchanged for money. Then that money gets traded for another product. And such and so on. The cycle continues. But a market can occasionally take the form of a classic barter where a product is directly exchanged for another product.
Monopoly and monopsony exist along the very extreme ends of a continuum called the market spectrum. Placement on it is determined by seller to buyer ratio.
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MARKET
Any place and time where a trade occurs. The exchange can occur in real life or virtually. Money is either traded for a product, or occasionally, a product can be directly exchanged for another product, as is the case with barter.
The three primary markets.
MONOPOLY
A market with a single seller of a product that has many buyers.
A monopolist amasses wealth by artificially restricting the quantity supplied, thereby increasing the product’s price above what would be natural if the monopolist had any competing sellers.
The motive of the lone seller is to increase their profit through an unnaturally high price.
Monopoly
A monopoly is primarily characterized as a single seller of a product with many buyers. It exercises total control over the product’s price—so long as it falls within the very upper or lower range of what buyers are willing and able to pay. The critical two words here are willing and able. Both conditions must be met for a monopolist to be successful.
The monopolist will generally seek to maximize a price within the upper range of demand to as much as possible—or near the highest price of what all buyers summed together are willing and able to pay. This is accomplished by unnaturally restricting the quantity of product that gets sold. The monopoly is the sole distributor.
In other words, "Buy from us at this high price or we aren't selling! You'll get no product at all!"
The monopoly is shrewd but correct. No competing sellers exist to bid the price downward.
Thus, the buyers mostly have no control over the price. They only have four options: (1.) keep purchasing the product (2.) unionize to create a counter-monopsony (3.) impose enormous pressure on the government to break-up the monopoly or (4.) locate a substitute product with dramatically lower demand (to jolt the price down in the short-term) but with current supply that gradually increases to compete harder against the monopolist (to decrease the price even further in the long-term.)
The third and fourth options have historically been the best long-term solutions for buyers caught in a market with monopoly traits. The second option is generally a last resort.
Monopoly as a term originates from the Greek monos, meaning one or single; and pōlion, to sell. One seller.
Monopsony
As an inverse to the above, a monopsony is primarily characterized as a single buyer of a product with many sellers. It also exercises total control over the product’s price—so long as it falls within the very lower or upper range of what sellers are willing and able to accept. Again, the critical two words here are willing and able. Both conditions must be met for a monopsonist to be successful.
The monopsonist will generally seek to minimize a price within the lower range of supply to as little as possible—or near the lowest price of what all sellers summed together are willing and able to accept. This is accomplished by unnaturally restricting the quantity of product that gets bought. The monopsonist is the sole consumer.
In other words, "Sell to us at this low price or we aren't buying! You'll get no money at all!"
The monopsony is also shrewd but correct. No competing buyers exist to bid the price upward.
Thus, the sellers mostly have no control over the price. They only have four options: (1.) keep selling the product (2.) unionize to create a counter-monopoly (3.) impose enormous pressure on the government to break-up the monopsonist or (4.) create a substitute product with dramatically lower supply (to jolt the price up in the short-term) but with current demand that gradually increases to compete harder against the monopsonist (to increase the price even further in the long-term.)
As with monopoly, the third and fourth options have historically been the best long-term solutions for sellers caught in a market with monopsony traits. And again, the second option is generally a last resort.
Monopsony as a term originates from the economist Joan Robinson. Like it’s mirror image, she borrowed from the Greek monos, meaning one or single; and opsōnía, to purchase. One purchaser.
MONOPSONY
A market with a single buyer of a product that has many sellers.
A monopsonist amasses wealth by artificially restricting the quantity demanded, thereby decreasing the product’s price below what would be natural if the monopsonist had any competing buyers.
The motive of the lone buyer is to increase their profit through an unnaturally low cost.
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For our purposes, a monopoly exists along the far left and a monopsony exists along the far right of the market spectrum. Prices increase on the left and decrease on the right.
PERFECT COMPETITION
A market with many sellers and many buyers of a particular product.
Neither the sellers nor buyers have any power over the product’s price. There are too many sellers and too many buyers to exert or coordinate any control.
The products are homogenous, with buyers unable to distinguish one seller’s product from any other.
There are no gaps in anyone’s knowledge about the market either. The market is unable to veer toward monopoly or monopsony as a result.
Both profits and losses occur as supply and demand fluctuate.
The forces of monopoly, monopsony, and their counter-unions are all forms of collectivization and are known to have slowly deteriorating or pernicious effects on a society. Most are prone to corruption. A monopoly collectivizes many buyers under one seller, while a monopsony collectivizes many sellers under one buyer.
Some exceptions exist to the undesirability of collectivization for purposes of safety. For instance, unions of electricians and coal miners result in reduced accidents and fatalities. Other exceptions are made not for moral reasons, but rather, due to reasons of practicality. As an example, a town’s water and power department cannot be easily competed against. Laying new underground pipe and erecting additional power lines is too difficult and expensive to be done by more than one entity. A monopoly must be granted. But in that case, the legislative and executive branches of government should act as a counter-monopsony on behalf of the buyers. Monopoly prices are suppressed through force of law.
Perfect Competition
In the scientific study of wealth—referred to as economics—the ideal market is called perfect competition; and it resides directly in the center of the market spectrum. Perfect competitors are unable to collectivize.
Suppliers and demanders have no power over the price of a product that exists within a perfectly competitive market. There are simply too many sellers and too many buyers to exert or coordinate any control.
The product is also homogenous. This means any individual seller’s product has no features that would differentiate it from all the other suppliers who make the exact same thing. Advertising does not exist in this market. It is not only unnecessary, but it may cause a loss.
Two classic examples are given to represent this category. First are foreign exchange markets. Here numerous sellers and numerous buyers trade a nation’s currency for another nation’s currency. And second are pre-Industrial Age farmer’s markets. During this period, farmers acting as many sellers exchanged their agricultural goods for money to villagers acting as many buyers in a town square.
Neither of these are a flawless or exact representation of perfect competition. But as models they come close. Gaps in knowledge about the market occur, so when these two examples near perfect competition they can still veer to the far left or far right. However, this is rare.
All three markets—monopoly, perfect competition, and monopsony—are each considered theoretical by economic scientists. They do not exist in the real world. Rather, four sub-markets exist in-between these extremes that we see in everyday reality.
The four sub-markets.
On the left side of the market spectrum, we have oligopoly and monopolistic competition.
Oligopoly
Oligopoly has many of the same features as monopoly, but unlike a true monopoly, an oligopoly has at least one or more competing sellers. Think of two major railroads selling expensive tickets to passengers who act as many buyers.
The oligopoly exercises a great but not absolute power to maximize the price of the product they sell—again, so long as it is within the upper range of demand or what all the numerous buyers summed together are willing and able to pay. Oligopolies can exert total control over the price only if they collude together to act as a single monopoly. This sometimes occurs. But it is often the smallest of the oligopolies that secretly defects from any collusion should it form. They have the greatest incentive to do so—to gain more money. This is how drug cartel wars frequently begin.
Oligopoly as a term originates from the Greek oligo, meaning small number; and pōlion, to sell. A small number of sellers.
Monopolistic Competition
Monopolistic competition is so named because it has elements of two markets: a few features of monopoly, though it leans closer to perfect competition. As a seller, it exercises some control over the price but not as much as an oligopoly. The little pricing power that a monopolistic competitor holds is determined by their branding and any unique qualities they offer to buyers.
Think of eight hundred unknown writers. They are all competing against each other to sell books to one thousand readers who act as the buyers.
Granted, the buyers outnumber the unknown writers, which gives these authors some pricing power as sellers—but not by a huge margin. The ratio is 800 sellers : 1000 buyers. There are still a lot of unknown writers—eight hundred of them. So, who do the one thousand readers choose to buy from? Branding and unique qualities are necessary to distinguish one monopolistic competitor—in this case, an unknown writer—from the other seven hundred and ninety-nine. Monopolistic competitors are thus frequent advertisers. This pulls demand away from rival sellers. That allows for a modest increase in the author’s book price, which benefits the unknown writer.
Our unknown writer’s ad takes the form of a marketing banner in an online bookstore. “Mystery Thriller!”
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And on the right side of the real-world market spectrum are the rarely spoken about, but just as important, monopsonistic competition and oligopsony. They are a mirror reflection of the previous two markets. The ratio of buyers to sellers is simply reversed.
Monopsonistic Competition
Monopsonistic competition is so named because it has elements of two markets: a few features of monopsony, though it leans closer to perfect competition. As a buyer, it exercises some control over the price but not as much as an oligopsony. The little pricing power that a monopsonistic competitor holds is determined by their reputation and any unique compensation they offer to sellers.
Think of eight hundred small ranchers. They all compete against each other to buy labor from one thousand cowboys who act as the sellers.
Granted, the sellers outnumber the small ranchers, which gives these employers some pricing power as buyers—but not by a huge margin. The ratio is 1000 sellers : 800 buyers. There are still a lot of small ranchers—eight hundred of them. So, who do the one thousand cowboys choose to work for? Reputation and unique compensation are necessary to distinguish one monopsonistic competitor—in this case, a small rancher—from the other seven hundred and ninety-nine. Like their mirror image, monopsonistic competitors are thus frequent advertisers. This pulls supply away from rival buyers. That allows for a modest decrease in the employer’s labor price, which benefits the small rancher.
Our small rancher’s ad takes the form of an employment listing in a local newspaper. “Help Wanted!”
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Now despite their name, both monopolistic competition and monopsonistic competition are considered good or moderate markets in the real world. They are close to the ideal theoretical market in the center of the spectrum—where competition between buyers and sellers is at a maximum.
On a practical level, these two categories are the best a society can achieve long-term.
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Oligopsony
Oligopsony has many of the same features as monopsony, but unlike a true monopsony, an oligopsony has at least one or more competing buyers. Think of two major auto manufacturers depressing the wages of assembly line workers who act as many sellers.
The oligopsony exercises a great but not absolute power to minimize the price of the product they buy—again, so long as it is within the lower range of supply or what all the numerous sellers when summed together are willing and able to accept. Oligopsonies can exert total control over the price only if they collude together to act as a single monopsony. This sometimes occurs. But it is often the smallest of the oligopsonies that secretly defects from any collusion should it form. They have the greatest incentive to do so—to gain more money. This is how employer bidding wars frequently begin.
Oligopsony as a term originates from the Greek oligo, meaning small number; and opsōnía, to purchase. A small number of purchasers.
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For reference, here is the full market spectrum.
Innovators on the
market spectrum.
A critical point about our market spectrum so far is that it has not modeled new innovators very well. Notice that oligopoly and monopolistic competition already have many buyers assumed on the left side of the spectrum. Likewise, monopsonistic competition and oligopsony already have many sellers assumed on the right.
In the real world, a brand new good or service with pioneering or experimental features likely does not have more than a few buyers or a few suppliers readily in place. Compare any innovator to established businesses. Their market will be smaller to start.
Similarly, a ratio of 50 : 100 is equivalent to a ratio of 1 : 2, but the numbers used to express the second ratio are still smaller. Innovators who challenge established businesses or enter obscure markets, therefore, need to be modeled differently on our spectrum.
As an example, an innovator enters next to an oligopoly market—where he likely finds low demand. The buyers barely outnumber the new seller. The innovator’s product competes against the two big oligopolies, but it is still modestly unique, so the new seller has some characteristics of monopoly. As a result, the new seller is placed on the left side of the market spectrum when viewed as a whole, but still to the right of the two oligopolies, since his market is close to perfect competition. The innovator is categorized as monopolistic competition. That is, technically speaking.
But it is more like a baby monopolistic competitor. Demand is just starting to grow. It is nascent.
Tech startups are a good instance of this phenomena. Thus, if we are to use this spectrum to model an oligopoly-challenger, we should allocate some tiny portion of the pre-existing demand of the current oligopoly over to the new market entrant. Let us say 1.5 red blocks. We will label this category as nascent monopolistic competition.
Notice the ratio. The nascent monopolistic competitor has a ratio of 1 seller : 1.5 buyers. These are small numbers. But that ratio is also equivalent to 20,000 sellers : 30,000 buyers. Both ratios would be categorized as monopolistic competition.
The two oligopolists and the innovator all have upward pricing power, of course. However, the oligopolists retain more.
Next, we will show this seed of demand growing a tiny amount over time as it pulls demand from the oligopolists. Chances are the nascent monopolistic competitor will never overcome the effort necessary to pull a well-established oligopolist’s demand away entirely. He manages to get another 0.5 red blocks. The seed fails to sprout. The demand of all parties likely freezes on the spectrum at some point, too. The tech startup holds onto the little demand they managed to draw. It was a noble attempt. (And two red blocks is being very generous.) The story of the tech startup’s first product ends here.
But then—if they are good entrepreneurs—the tech startup will attempt to innovate a second product. It will only be a partial substitute this time, and thus it will reside in a more oblique and obscure market. This market is ignored by the oligopolists. The tech startup chooses wisely to no longer compete head on.
All suppliers in the second market are small. No oligopoly dominates. But distinguishing this second market is the enormous potential to grow rapidly in buyers. This can occur when an innovated product combines two or more forms of usefulness—or what is called utility. The smartphone is a prominent example. This combined two useful things: a cell phone with a computer. On their own, each product was already useful. Combined, they changed the world.
The same principle of combined-utility was applied to create photocopiers, steamboats, energy drinks, payment processing software, fast food production, movie theatres, cork pinup boards, etc. The list is endless.
The innovation of these products and the subsequent maneuver of business operations to supply them is both a science and an art. Startups call this process a pivot.
The market our tech startup pivots into then will be categorized as (nascent) monopolistic competition. Demand for this second product is now like the water behind a leaking dam. Demand begins with a few drips…. Then a giant crack forms, and demand starts to pour through. The dam bursts. Vwoosh! Red squares.
This second product can no longer be categorized as competitive, and it soon becomes a monopoly. The tech startup now resides on the very far left of the market spectrum. Congratulations. Here is your Get Out of Jail Free card.
But the monopoly is only temporary. Almost all monopolies are.