A monopsony is a single buyer, the mirror image of a monopoly. A monopoly must cut its price to sell more (Why Marginal Revenue Is Below Price); a monopsony employer must raise its wage to hire more. Instead of the shifting curves of Shifts in Labor Demand and Supply, it chooses a point on the labor supply curve.
Key idea
To hire one more worker, a monopsonist must pay a higher wage to all its workers, so the marginal factor cost (MFC, also called marginal resource cost) is above the wage. It hires where $MRP = MFC$, then pays the wage on the supply curve at that number of workers. The result: fewer workers and a lower wage than a competitive labor market. With linear supply $w = w_0 + sL$, $MFC = w_0 + 2sL$.
Why it works
Suppose 10 workers would work for \$15 an hour, but an 11th needs \$16. Hiring the 11th costs \$16 for that worker plus \$1 more for each of the other 10: \$26 in all. That's the MFC. Since it's above the wage, the employer stops hiring earlier than a competitive employer would, and the wage only has to be high enough to attract that smaller number of workers. In this model, a minimum wage set between the monopsony wage and the competitive wage makes the MFC flat up to the supply curve and can raise employment.
Worked example: A one-company town
Labor supply is $w = 5 + L$ (dollars an hour), and workers' MRP is $35 - L$. Find the monopsony employment and wage, and compare with a competitive market.
- $MFC = 5 + 2L$ (twice the slope of supply).
- $MRP = MFC$: $35 - L = 5 + 2L$, so $L = 10$.
- Wage from supply: $w = 5 + 10 = \$15$.
- Competitive: $35 - L = 5 + L$ gives $L = 15$ and $w = \$20$. The monopsony hires 5 fewer and pays \$5 less.
Answer: 10 workers at \$15 (competitive: 15 at \$20).
Worked example: MFC from a supply schedule
An employer can hire 3 workers at \$12 an hour or 4 at \$13. What is the marginal factor cost of the 4th worker?
- Labor cost with 3: $3 \times \$12 = \$36$. With 4: $4 \times \$13 = \$52$.
- $MFC = \$52 - \$36 = \$16$, more than the \$13 wage.
Answer: \$16 an hour.
Common mistake
Reading the wage from the MFC curve at the hiring point. MFC says what the last worker costs the firm; the wage is what workers need to be willing to work, which is on the supply curve. In the example, MFC at 10 workers is \$25, but the wage is \$15. Check: the wage must be a point on the labor supply curve.
Economists agree on this model's logic. How much monopsony power real employers have, and so what a particular minimum wage does to employment, is studied and debated; the evidence differs across places, industries and the size of the increase.