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The Limits of Monopsony Pricing Power in the Markets for Defense Goods

By David T. Day, 1st Lt, USAF

Due to the structure of defense acquisition, the Department of Defense (DoD) purchases goods in both competitive and non-competitive markets, and each environment presents unique challenges to the DoD’s ability to influence prices.  Operational level purchasing occurs in a competitive market, and small buying offices have relatively little price determination power.  The centralization of buying offices could result in greater influence on prices as various smaller purchases are conducted by a single buyer.   Any price influence would vary by good, and would be most greatly affected by the civilian use of such goods.  If a good has little civilian application, the centralization of buying organizations could have a noticeable impact on price.  However, if the good has widespread civilian use the market would remain competitive and the DoD would not achieve price determination power.  Large scale military system purchases frequently occur in a non-competitive environment where the DoD is the only purchaser, also known as a monopsony.  While the Department of Defense is a monopsonist in the market for restricted military hardware, true market efficiency in production of national defense is not necessarily the DoD’s objective.  The size of the military and the quantity of military goods purchased by the DoD are dictated by external military threats and the domestic political environment.  National defense and military readiness often require resources beyond the point of market-clearing efficiency, and requirements frequently push the quantity of goods demanded beyond the efficient market price.  Unable to independently dictate the quantity purchased, the DoD loses its monopsony power.  In these cases, the inflexible quantity requirement can actually create higher prices as the producers of the good will require a higher price to offset the additional cost required for greater production.  These challenges in both the competitive and non-competitive markets present obstacles to the DoD’s ability to influence prices.

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