MONOPSONY - WAGE DETERMINATION IN IMERFECTLY COMPETITIVE LABOUR MARKETS: AQA Economics Specification Topic 4.1

Topic 4.1 - Individuals, firms, markets and market failure

Snapshot of the AQA syllabus topic area we’ll be covering in this post.

monopsony - tHE DETERMINATION OF RELATIVE WAGE RATES AND LEVELS OF EMPLOYMENT IN imperfectly COMPETITIVE LABOUR MARKETS: THE LABOUR MARKET

AQA students must understand the following content [taken from the syllabus]

• How various factors such as monopsony power, trade unions and imperfect information contribute to imperfections in a labour market.

• How, in a monopsony labour market, the employer can use market power to reduce both the relative wage rate and the level of employment below those that would exist in a perfectly competitive labour market.

ESSENTIAL INFORMATION

[NOTE: supplementary knowledge, supporting diagrams and questions at the end]

Introduction:

In the previous post, we discussed the outcome of perfectly competitive labour markets with respect to wage determination. In this post, we will instead examine wage determination within imperfectly competitive markets.

In the world of economics, perfect competition is not the only labour market structure that defines wage outcomes in markets. Imperfections frequently result from elements like monopolistic power, trade unions, and incomplete information. Market inefficiencies can result from these flaws, which can have a major impact on pay rates and employment levels. In this post, we will examine how these factors affect market defects and pay particular attention to how monopsony power affects employment and wage rates in labour markets.

1. Factors Contributing to Imperfections in Labour Markets:

a. Monopsony Power:

A market condition known as monopsony occurs when there is just one customer - or in the case of the labour market - employer. In these situations, the employer has considerable market power and is able to set the wage rates and employment levels. Monopsonistic employers can lower both the relative pay rate and the amount of employment below levels that would be present in a labour market with perfect competition by using their market dominance.

b. Trade Unions:

Workers' collective negotiating power is represented by trade unions. They bargain with employers to obtain better pay, benefits, and working conditions for their members. Strong trade unions can result in higher wages and better worker protections, but they can also cause labour market rigidities and cause unemployment when compared to competitive labour markets.

c. Imperfect Information:

Asymmetry of information between employers and employees can skew wage determination. Employers may take advantage of workers' inadequate awareness of industry standards for pay or job requirements to provide cheaper compensation.

2. Impact of Monopsony Power on Wage Rates and Employment:

The employer has a significant amount of power over the wage-setting process in a monopsonistic labour market. By hiring fewer people at a lower wage, they can put downward pressure on wages. In contrast to a market with perfect competition, this results in a lower relative pay rate. Additionally, because there are fewer employment possibilities, monopsonistic businesses may force workers to accept lesser pay because there aren't many other options available.

[see monopsony diagram at the end of this page]

Conclusion:

Multiple variables that contribute to market inefficiencies are characteristics of imperfectly competitive labour markets. The determination of wages and employment levels can be greatly impacted by monopoly power, trade unions, and incomplete information. To solve market inefficiencies and work towards fair and effective wage outcomes, governments, employees, and employers must have a thorough understanding of these issues. Stakeholders can endeavour to create a more balanced and equitable employment market environment by recognising the difficulties created by imperfectly competitive labour markets.

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SUPPLEMENTARY KNOWLEDGE:

You should also understand:

• Monopsony employers are wage setters as the amount of workers they employee is high relative to the supply of labour - they have great wage setting power - so, in essence, just like a monopoly they are price makers

• Monopsony employers are assumed to be profit maximisers - this means they’ll set the wage at the point where MRP = MC

• Total employment in the market will be lower - this is because the monopsony employer drives down wages to a level lower than would be under perfect competition - lower wages disincentivise some workers from supplying their labour

• Monopoly firms will alot of the time also be monopsony firms - for example, if you wish to purchase a computer, your options will be either Microsoft, Apple or Google when it comes to the operating system. On the other side of the coin, Microsoft, Apple and Google are probably some of the largest employers of software developers

• A strong trade union in presence of a monopsonistic market can be a good thing for labour markets that underpay workers

  • a good example of this is the significant size of trade unions that operate within the realm of state-run services such as the healthcare, schools, public transport etc

  • in such cases, a trade union can restore the balance of market power and successfuly campaign for better pay, fewer working hours and better working conditions within their job roles

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SUPPORTING DIAGRAMS:

diagram showing a monopsony employer in a labour market - the perfectly competitive market results in the competitive wage and the labour employed of Qc - this is at the level where market supply (S) = market demand (D) - a monopsony employer sets the wage at the profit maximising level MRP = MC - looking at the diagram, the quantity of labour employed by the monopsony employer is Qm and the respective wage rate is lower than the competitive wage - as a matter of fact, the monopsony employer can afford to pay a higher wage, but as a profit maximising firm they underpay workers so they can make more profit

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SUPPORTING QUESTIONS

Question 1: What is a monopsony employer in the context of labour markets?

Answer:

A single buyer or employer that dominates the labour market is referred to as a monopsony employer. The employer now has considerable market power to set wage rates and employment levels. This is in contrast to a perfectly competitive labour market where there would be multiple small firms hiring workers.

Question 2: How does a monopsony employer use its market power to influence wage rates and employment levels?

Answer:

A monopsony employer can lower employment levels and relative wage rates below those that would be present in a labour market with perfect competition. They can impose downward pressure on salaries and restrict job possibilities for workers by hiring fewer people and paying less than the competitive wage.

Their profit maximising nature coupled with the lack of competitor employers means that a monopsony employer is able to earn supernormal profits by underpaying workers. A monopsony’s chosen level of workers hired corresponds with the profit maximising wage rate - this is achieved at the point MRP = MC.

Question 3: What role do trade unions play in imperfectly competitive labour markets?

Answer:

Workers' collective negotiating power in the labour market is represented by trade unions. Trade unions bargain with employers on behalf of employees to obtain better pay, benefits, and working conditions. Strong trade unions operating within a monopsonistic market can work to balance the market power of monopsonistic firms and pursue more favourable wage outcomes. However, when a trade union operates in a more competitive market, the outcome may be negative and create additional unemployment.