Monopsony - Static Monopsony in A Labor Market

Static Monopsony in A Labor Market

The standard textbook monopsony model refers to static partial equilibrium in a labor market with just one employer who pays the same wage to all its workers. In this model, the employer is assumed to be a firm facing an upward-sloping labor supply curve (as generally contrasted with an infinitely elastic labor supply curve), represented by the S blue curve in the diagram on the right. This curve relates the wage paid, to the level of employment, and is denoted as the increasing function . Total labor costs are then given by . Assume now that the firm has a total revenue, which increases with according to the concave function . It wants to choose to maximize profits, which are given by:

.

This leads to the first-order condition:

.

The left-hand side of this expression is the marginal revenue product of labor (roughly, the extra revenue produced by an extra worker) and is represented by the red MRP curve in the diagram. The right-hand side is the marginal cost of labor (roughly, the extra cost due to an extra worker) and is represented by the green MC curve in the diagram. It should be noticed that this marginal cost is higher than the wage paid to the new worker by the amount

.

This is because the firm has to increase the wage paid to all the workers it already employs whenever it hires an extra worker. In the diagram, this leads to an MC curve that is above the supply curve S.

The first-order condition for maximum profit is then satisfied at point A of the diagram, where the MC and MRP curves intersect. This determines the profit-maximising employment as L on the horizontal axis. The corresponding wage w is then obtained from the supply curve, through point M.

The monopsonistic equilibrium at M should now be contrasted with the equilibrium that would obtain under competitive conditions. Suppose a competitor employer entered the market and offered a wage higher than that at M. Then every employee of the first employer would choose instead to work for the competitor. Moreover, the competitor would gain all the former profits of the first employer, minus a less-than-offsetting amount from the wage increase of the first employer's employees, plus profits arising from additional employees who decided to work in the market because of the wage increase. But the first employer would respond by offering an even higher wage, poaching the new rival's employees, and so forth. In other words, a group of perfectly competitive firms would be forced, through competition, to intersection C rather than M. Just as a monopoly is thwarted by the competition to win sales, minimizing prices and maximizing output, competition for employees between the employers in this case would maximize both wages and employment, as shown in the graph.