3.1.6.4 - Monopsony and imperfect labour markets

Sources of labour-market power and friction

An employer can have wage-setting power when workers cannot readily move to alternatives.

A monopsony is a market with one buyer; in labour markets the buyer is the employer. Monopsony power also describes a degree of employer buying power where alternatives exist but are weak. A specialist employer in an isolated area may face little effective recruitment competition because moving is costly and workers' skills are difficult to transfer. Define the relevant occupation and location: many employers nationally do not guarantee many realistic alternatives for a particular worker.

Imperfect information about pay or vacancies weakens workers' ability to switch. Search costs, long notice periods and geographic or occupational immobility can make the labour supply facing an individual firm upward-sloping: to attract substantially more workers it must offer more attractive pay. A wage-taking competitive firm instead faces a horizontal supply at the market wage.

Trade unions introduce collective bargaining on the workers' side. They may counter employer power or negotiate wages above a competitive level. Their existence is a departure from atomistic wage-taking behaviour; whether it improves the outcome depends on the starting market and the bargain. The next lesson analyses those effects in detail.

Hiring another worker can raise the whole wage bill

For a monopsonist paying a common wage, the marginal cost of labour exceeds the wage when hiring more requires a pay rise for existing staff too.

The upward labour supply curve shows the wage needed to attract each workforce. If all workers receive that common wage and there are no other labour costs, it is also average cost of labour (AC). Total labour cost is wage multiplied by employment. Marginal cost of labour (MC) is the additional total cost from expanding employment, including any rise in pay for existing workers.

This original discrete example uses pounds per worker per day:

The eleventh worker costs £52 directly, but each of ten existing workers also gets £2 more. MC is $572-500=72$ pounds per day, or $52+10\times2=72$, not £52. AC at 11 workers is $572/11=52$. MC therefore lies above AC where an expanding workforce requires a higher common wage.

If the employer could pay each new worker a different wage without raising existing pay, this particular MC-above-AC mechanism would change. The standard diagram assumes a uniform wage, upward-sloping supply and profit maximisation. Other recruitment costs and contracts may complicate actual behaviour.