Bilateral monopoly is a market structure in which there is only a single buyer (monopsony) and a single seller (monopoly). Game theory is frequently used when analysing this kind of market structure. Analysing bilateral monopolies becomes relevant when analysing factor markets, specially when analysing the labour market.

Depending on which side has greater negotiation power there can be different outcomes that resemble more or less its two extreme possibilities, as shown in the adjacent figure. The obvious and antagonistic scenarios that can result in this market are monopsony and monopoly. When the demand side holds all the negotiation power we will be dealing with a monopsony-like situation such as m, where price P_m is lower than the monopolist price (P_M) and the price of a perfectly competitive market (P_PC). When negotiation power is held by the supply side, the monopolistic firm will sell less quantity (Q_M) than the monopsonist would buy if it had more power (Q_m). However, when the bargain power is equally shared between the two sides there may be joint profit maximisation, which can be done by colluding, or even vertical integration may occur if both firms merge, which would get both firms to jointly get an equilibrium corresponding to perfect competition (C). A bilateral monopoly, however, will have worse results for both firms. The quantity sold will be very low (Q_BC) at a rather low price (P_BC).

A bilateral monopoly can also be considered as a firm that has high negotiation power with its clients, which would get the firm to be considered as a monopoly, and high negotiation powers with its suppliers, which would mean the firm is also a monopsony. Consider as an example Standard Oil, back in the days before its breakup. In 1911, the United States Supreme Court ruled that the company was an illegal monopoly. However, Standard Oil could also be considered as a monopsony: being the biggest oil corporation in the US, it had incredible power when negotiating prices with its suppliers when acquiring parts for its refining factories.

Monopsony (from the greek «mónos», single, and «opsõnía», purchase) is a market structure form of imperfect competition characterized by the existence of a unique buyer and many sellers. It is a similar case to monopoly but were the monopolistic powers come from the demand side and not from the supply one. Joan Robinson first coined this term in her book “The Economics of Imperfect Competition” 1933.

There are not many cases of real monopsonies in the world, however the many occur in any input market. Examples of this include the one of the United States over defence and security assets in the economy, which started during the cold war. Nevertheless, the most significant case analysed is monoposony in the labour market. Frictions between the job searching progress and joining to it, causes employees to be uncomfortable about leaving their workplace.

This position gives the employer monopsonist powers and allows them to push wages down to the marginal revenue product providing them with higher profits. Governments have the possibility to set a minimum wage to prevent wages dropping to very low levels.

Markets with the same features as monopsonies but where there are more than one buyer, being the number of buyers still small enough, are known as oligopsonies.

The Lerner index measures a firm’s level of market power by relating price to marginal cost. When either exact prices or information on the cost structure of the firm are hard to get, the Lerner index uses price elasticity of demand in order to measure market power: the Lerner index is equivalent to the inverse of the elasticity in its absolute value faced by the firm when price is set to maximise profits. Both formulas are equivalent: 

Economist Abba Lernerdeveloped this relationship in his article “The Concept of Monopoly and the Measurement of Monopoly Power”, 1934. This was Lerner’s first major article on welfare economics, in which he introduced the idea that monopolies are a matter of degree, stating that their power depend on the excess of price over marginal costs, discussing also Pareto optimality and loss of total welfare in monopolies.

The extent to which a firm can take advantage of its monopolistic condition will highly depend on the flexibility of its demand curve. If it is more rigid (steeper), it will only have to reduce its production in order to achieve a higher price. However the more flexible (flatter) the demand curve is, the less market power the firm has to increase prices.

Therefore, Lerner index will always be between 0 and 1: the closer it is to 0, the closer it is to perfect competition; the closer it is to 1, the higher market power the seller has and hence closer to a monopoly. A monopolist seeking to maximise profits will never be on the inelastic part of the demand curve, E < 1, which is why elasticity will always be such as ∞ ≥ E ≥ 1.

Surplus in economics refers to the profits (in terms of money or welfare) an individual or group of individuals is capable of extracting from the correct functioning of markets. Welfare economics analyses these surpluses in order to determine whether a market structure is socially optimal. From a microeconomic point of view, we can differentiate between consumer and producer surplus, which jointly form what is known as total or economic surplus, also known as total welfare. Let’s analyse them separately.

Consumer surplus:

Consumer surplus is quite easy to understand, since it’s the difference between how much someone is willing to pay for a given quantity of goods, an how much they actually pay. In this case, the demand curve is given by the willingness to pay of consumers, how much they will pay for a good.

Let’s consider the market for books, and that we have three potential customers: Arthur, Bertil and Carl. Arthur is willing to pay less than $25 for a book, Bertil would pay less than $20 and Carl would pay less than $15. If price is set at $25, no one buys books. When the price drops to $20, Arthur buys a book, and Arthur’s consumer surplus corresponds to area A. Note that this area equals $5, being this the difference between how much he was willing to pay ($25) and how much he actually pays ($20). If the price drops again, this time to $15, Bertil buys a book. In this case, Bertil’s consumer surplus corresponds to area B. It must be noted that, since the price of a book dropped even more, Arthur’s consumer surplus increased by A’. Both B and A’ equal $5. The same happens when Carl buys a book when price drops to $10. Consumer surplus, understood as the sum of all individual consumer surpluses, corresponds to area A+A’+A’’+B+B’+C.

When we repeat this process with a far greater number of buyers, we get a nice, straight demand curve. Now, let’s say the price for a given good is set at p₀. In that case, consumer surplus is area CS. When price drops to p₁, quantity sold increases. On the one hand, there is an increase on the consumer surplus of initial consumers, being this equal to area CS’. On the other hand, new consumers are willing to buy, being their consumer surplus nCS.

Producer surplus:

This is the exact opposite concept, since in this case we examine the market from the producers’ point of view. Producer surplus is the difference between the price the producer is paid and the cost of production.

Let’s consider again the market for books, now from the perspective of three producers: David, Edward and Frank. The supply curve corresponds to each producer’s costs of production, being $2 for David, $4 for Edward and $8 for Frank. If the price is lower than $2, no one will supply books since they’ll incur in losses. Now, if the price increases to $4, David sells a book, since he’ll be able to make a profit from the sale. This profit corresponds to D, his producer surplus. If the price increases to $8, Edward will also sell a book, having a producer surplus of E. In this case, David’s producer surplus will increase by $4 (area D’). The same will happen when the price gets over $8, let’s say $10. Producer surplus, understood as the sum of all individual producer surpluses, corresponds to area D+D’+D’’+E+E’+F.

When we repeat this process with more sellers, we get a straight supply curve. Now, let’s say the price for a given good is set at p₀. In that case, producer surplus is area PS. When price increases to p₁, quantity sold increases. On the one hand, there is an increase on the producer surplus of initial producers, being this equal to area PS’. On the other hand, new producers are willing to sell, being their producer surplus nPS.

Total welfare:

Total welfare, also known as economic or total surplus, is equal to the sum of both consumer and producer surpluses. It can be understood as the surplus of society, since both consumers and producers are getting something from the exchanges taking place in the market.

The analysis of economic surplus is used to determine the total loss of welfare when comparing a perfectly competitive market to other market structures, such as monopolies or oligopolies. It is also used to analyse the impact of the implementation of new taxes.

Monopoly (from the greek «mónos», single, and «polein», to sell) is a form of market structure of imperfect competition, mainly characterized by the existence of a sole seller and many buyers. This kind of market is normally associated with entry and exit barriers.

All of these features give the monopolist the ability to set prices with the only limitation of consumers’ willingness to pay. Therefore, in monopolies, the seller is a price-maker and consumers will be price-takers.  The firm will choose its production output (q) and price (p) in order to maximise revenue (π). The optimal condition, where we’ll have marginal cost (MC) equals marginal revenue (MR), is given by: 

The extent to which a firm can take advantage of its monopolistic condition will highly depend on the flexibility of its demand curve. If it is more rigid (steeper), it will only have to reduce its production in order to achieve a higher price. However the more flexible (flatter) the demand curve is, the less market power the firm has to increase prices. This relationship between price elasticity of demand and market power can be described using the Lerner index. This index measures the firm’s level of market power by relating price to marginal cost, 

The result will always be between 0 and 1: the closer it is to 0, the closer it is to perfect competition; the closer it is to 1, the higher market power the seller has and hence closer to a monopoly. A monopolist seeking to maximise profits will never be on the inelastic part of the demand curve, E < 1, which is why elasticity will always be such as ∞ ≥ E ≥ 1. The Lerner index is equivalent to the inverse of the elasticity in its absolute value faced by the firm when price is set to maximise profits.

The implications of monopolies in terms of loss of efficiency and social welfare have been largely studied and discussed. If we compare the monopolistic price setting with the perfect competition one, we will find that while in the former price is greater than marginal cost, in the latter, they are equal. This implies that in general, price will be higher and output lower, if a firm behaves in a monopolistic manner, instead of a competitive one. And also in general, results for the firms will be to be better off, while it will be just the opposite for consumers. However, the gain for the firm will not sum up the total loss for the consumers. This is known as the deadweight loss of monopoly that comes as a result of the Pareto inefficiency of monopolies. From the equilibrium output of a monopoly to that of a perfectly competitive market, the consumers will be willing to pay more than marginal cost. This leaves space for improving efficiency, but monopolistic firms choose to produce less and set higher prices. This deadweight loss is represented by the areas A and B in the adjacent figure: while the monopolist gains area Cˈ and loses B, consumers transfer area Cˈ and lose A. As a result, firms increase their surplus, consumers lose part of it and in aggregate terms, society as a whole, will bury the deadweight loss.

Types of monopolies:

As we have previously explained, monopolistic firms maximise their profits with the level of output in which marginal cost equals marginal revenue. However we can distinguish different types of monopolies depending on how they achieve this. We can distinguish different types of monopolies:

Multiplant monopoly: firms which have many production plants and hence different marginal cost functions will have to choose the individual output level for each plant.

Bilateral monopoly: this market structure consists of a single buyer (monopsony) and a single seller (monopoly). Depending on who has greater negotiation power there can be different outcomes. Two possible scenarios may be in either one of them having all of the power, an intermediate solution may be found or a vertical integration may occur.

Multiproduct monopoly: instead of selling one product, the monopoly sells several. The firm will have to take into account how the changes in the price of one affect the rest of its products.

Discriminating monopoly: firms may want to charge different prices to different consumers, depending on their willingness to pay. Depending on the level of discrimination we have different degrees. The first degree or perfect discrimination is given when the monopolist sets the highest price that each consumer is willing to be pay. The second degree or nonlinear price fixing is given when price depends on the amount bought by the consumer. And finally, the third degree or market segmentation of price discrimination occurs when there are several differentiated consumers segments to which the firm will apply different prices, e.g. student or third age discounts.

Natural monopoly: this kind of monopoly occurs in industries in which, due to cost-technological factors, it is more efficient to have a single firm dealing with all of the production, as average costs are lower in the long run; a phenomenon known as subadditivity.