Monopsonistic Labor Markets
Picture a small town where one hospital employs almost every nurse. A nurse who doesn't like the pay can't just walk across the street to another hospital. Does that give the hospital the power to pay less than a nurse's work is worth to it? And how many nurses will it choose to hire? Let's work it out.
What Is a Monopsony?
In a competitive labor market, many firms bid for workers, so each firm is a wage taker. It can hire as many workers as it wants at the market wage.
A monopsony is a market with a single buyer, here a single employer of labor. Because that employer is the whole demand side of the market, it faces the entire upward-sloping labor supply curve. To hire more workers, it has to offer a higher wage.
Real examples are usually local and partial:
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a coal mine or textile mill that employs most of the people in a small town
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a hospital that is the only major employer of nurses in a rural county
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a poultry plant in a county with few other jobs
Few markets are pure monopsonies. Many are close enough that the model helps, and it is a standard AP® Microeconomics tool.
Define monopsony* in a labor market. Give one realistic example of a setting in the United States where a single employer might hire most of the workers in a local labor…
Define monopsony in a labor market. Give one realistic example of a setting in the United States where a single employer might hire most of the workers in a local labor market (for example, a small town with one large factory).
Why MFC Lies Above the Supply Curve
Marginal factor cost (MFC) is the extra total cost of hiring one more worker. Some books call it MRC, marginal resource cost.
$$MFC = \frac{\Delta TLC}{\Delta L}$$TLC is total labor cost, $w \times L$.
A competitive firm pays the same wage no matter how many workers it hires, so for it MFC = wage. A monopsonist is different. If it wants one more worker, it must raise the wage to attract that person. Unless it can pay each worker a different wage, it must give the same raise to all the workers it already has. The new worker's extra cost is her own wage plus the raises for everyone else.
Each worker's MFC is higher than the wage, and the gap grows with employment. So the MFC curve lies above the labor supply curve and is steeper. With a linear supply curve $w = a + bL$, we get $TLC = aL + bL^2$ and $MFC = a + 2bL$. The MFC curve starts at the same point on the vertical axis but rises twice as fast.
A monopsonist faces an upward-sloping labor supply curve. Explain why its marginal factor cost (MFC) of labor is greater than the wage. In your answer, state whether the…
A monopsonist faces an upward-sloping labor supply curve. Explain why its marginal factor cost (MFC) of labor is greater than the wage. In your answer, state whether the MFC curve lies above or below the labor supply curve.
A hospital is the only major employer of nurses in a small town. The table shows the labor supply of nurses it faces. | Nurses | Wage per hour | Total labor cost per…
A hospital is the only major employer of nurses in a small town. The table shows the labor supply of nurses it faces.
| Nurses | Wage per hour | Total labor cost per hour |
|---|---|---|
| 1 | $\$20$ | $\$20$ |
| 2 | $\$22$ | $\$44$ |
| 3 | $\$24$ | $\$72$ |
| 4 | $\$26$ | $\$104$ |
| 5 | $\$28$ | $\$140$ |
(a) Compute the marginal factor cost of each nurse (the 1st nurse's MFC is $\$20$).
(b) Explain why the MFC is greater than the wage for every nurse after the first.
The Hiring Rule: MRP = MFC, but Pay the Supply Wage
Recall from the last page that the marginal revenue product (MRP) is the extra revenue a worker brings in. Every profit-maximizing firm follows the same rule: hire workers as long as the MRP is at least as large as the MFC. Stop at the quantity where $MRP = MFC$.
The monopsonist differs from a competitive firm in the second step. It uses the MFC curve to choose the quantity. Then it goes down to the supply curve to find the wage, because the supply curve shows the lowest wage that gets that many workers to show up.
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Find where MRP = MFC. That gives the quantity of labor.
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From that quantity, go straight down to the labor supply curve. That gives the wage.
Now you can answer the question from the start of the page. Hiring one more nurse means raising the wage for every nurse, so each added nurse costs the hospital more than her own wage. The hospital stops hiring while her MRP is still above her wage. The gap between the two is the monopsonist's "markdown."
State the rule a profit-maximizing monopsonist uses to decide how many workers to hire. Then explain whether the monopsonist pays the wage found where MRP = MFC, or the…
State the rule a profit-maximizing monopsonist uses to decide how many workers to hire. Then explain whether the monopsonist pays the wage found where MRP = MFC, or the wage read from the labor supply curve at that quantity.
Use the hospital's labor supply table from the nurse example: wages are $\$20$, $\$22$, $\$24$, $\$26$, $\$28…
Use the hospital's labor supply table from the nurse example: wages are $\$20$, $\$22$, $\$24$, $\$26$, $\$28$ per hour for 1, 2, 3, 4, 5 nurses, so the MFC values are $\$20$, $\$24$, $\$28$, $\$32$, $\$36$. The hospital's MRP of nurses is $\$40$ for the 1st nurse, $\$36$ for the 2nd, $\$32$ for the 3rd, $\$28$ for the 4th, and $\$24$ for the 5th.
(a) How many nurses does the hospital hire to maximize profit?
(b) What wage does it pay?
(c) Is the wage equal to, above, or below the MRP of the last nurse hired? Explain what this means.
Monopsony vs. Competition, and the Minimum Wage
How different is the outcome from a competitive market? The figure above uses these linear curves: supply $w = 2 + 0.01L$ and $MRP = 20 - 0.01L$.
A monopsony hires fewer workers and pays a lower wage than a competitive market, and it creates a deadweight loss. This is the mirror image of a monopoly, which charges a higher price and sells a lower quantity.
A minimum wage in a monopsony
In a competitive labor market, a binding minimum wage raises the wage above equilibrium and reduces employment. In a monopsony the result can be different. A minimum wage $w_{min}$ means the firm cannot pay less, so it can hire as many workers as it wants (up to the supply curve) at exactly $w_{min}$. Its MFC is then flat at $w_{min}$. Hiring one more worker no longer forces raises for everyone, because everyone already earns $w_{min}$.
Using the curves above:
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A minimum wage of $\$10$ (above $\$8$, below the competitive $\$11$). At $\$10$, the supply curve gives $2 + 0.01L = 10$, so $L = 800$ workers are willing to work. The MRP stays above $\$10$ until $L = 1{,}000$ ($20 - 0.01L = 10$). The firm hires up to the smaller of the two limits, and supply is the binding one, so the MFC is $\$10$ out to $L = 800$. Employment rises from 600 to 800.
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A minimum wage of $\$11$ (the competitive wage). The firm hires 900, the competitive quantity. The deadweight loss disappears.
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A minimum wage of $\$15$ (above the competitive wage). At $\$15$, 1,300 workers would be willing to work ($2 + 0.01L = 15$), but the firm hires only where $MRP = \$15$, which is $L = 500$ ($20 - 0.01L = 15$). Here demand (MRP) is the limit. That is even fewer than the 600 workers the monopsony hired before, so employment falls, just as in a competitive market.
A town's labor market for fast-food workers is perfectly competitive, with equilibrium wage $\$14…
A town's labor market for fast-food workers is perfectly competitive, with equilibrium wage $\$14$ and 600 workers employed. Suppose instead that one company, acting as a monopsonist, hired all workers in this market with the same MRP and labor supply curves.
(a) Would the monopsonist hire more than, fewer than, or the same number of workers as the competitive market? Explain.
(b) Would the monopsonist pay a wage higher than, lower than, or the same as $\$14$? Explain.
(c) Is there a deadweight loss? Describe it in one or two sentences.
A textile mill is the only employer in a small town. Labor supply is $w = 4 + 0.02L$, where $w$ is the hourly wage in dollars and $L$ is the number of workers. The…
A textile mill is the only employer in a small town. Labor supply is $w = 4 + 0.02L$, where $w$ is the hourly wage in dollars and $L$ is the number of workers. The mill's marginal revenue product is $MRP = 24 - 0.02L$.
(a) Derive the total labor cost $TLC = wL$ and the marginal factor cost $MFC$.
(b) Find the profit-maximizing number of workers and the wage the monopsonist pays.
(c) Find the number of workers and the wage that would occur if the labor market were perfectly competitive.
(d) Compare your results from (b) and (c), and state how much less the monopsonist pays than the MRP of the last worker hired.
The only major employer in a rural county is a poultry plant acting as a monopsonist, paying a wage of $\$13…
The only major employer in a rural county is a poultry plant acting as a monopsonist, paying a wage of $\$13$ per hour. Policymakers consider imposing a binding minimum wage. Suppose the monopsonist's MRP at its current employment level is $\$18$ per hour.
(a) Draw (describe in words) a graph of the monopsony labor market with the labor supply curve, MFC, and MRP, and identify the profit-maximizing quantity and wage.
(b) Explain why a minimum wage set above $\$13$ but below the competitive wage could increase employment in a monopsony, in contrast to a competitive labor market.
(c) Explain what happens to employment if the minimum wage is set well above the competitive wage.
(d) A student argues, "A monopsonist always hires fewer workers than a competitive market, so any minimum wage hurts workers." Evaluate this claim.