Economics: Labor Demand and Supply in a Monopsony

Labor Demand and Supply in a Monopsony

A labor market in which there is only one firm demanding labor is called a monopsony. The single firm in the market is referred to as the monopsonist. An example of a monopsony would be the only firm in a “company town,” where the workers all work for that single firm.

Wage-searching behavior. Because the monopsonist is the sole de-mander of labor in the market, the monopsonist's demand for labor is the market demand for labor. The supply of labor that the monopsonist faces is the market supply of labor. Unlike a firm operating in a perfectly competitive labor market, the monopsonist does not simply hire all the workers that it wants at the equilibrium market wage. The monopsonist faces the upward-sloping market supply curve; it is a wage-searcher rather than a wage-taker. If the monopsonist wants to increase the number of workers that it hires, it must increase the wage that it pays to all of its workers, including those whom it currently employs. The monopsonist's marginal cost of hiring an additional worker, therefore, will not be equal to the wage paid to that worker because the monopsonist will have to increase the wage that it pays to all of its workers.

A numerical example of a monopsony market is provided in Table 1 . The first two columns provide data on the market supply of labor that the monopsonist faces. The third column reports the total cost to the monopsonist of hiring each worker, which is just the wage times the number of workers. The fourth column reports the marginal cost of labor, which is the change in monopsonist's total cost of labor as it hires additional workers.

TABLE 1

A Monopsonist's Marginal Cost of Labor

Labor (number of workers)	Wage (per hour)	Total cost of labor	Marginal cost of labor
1	$10	$10	$10
2	15	30	20
3	20	60	30
4	25	100	40
5	30	150	50

Suppose the monopsonist wants to increase the number of workers that it hires from 2 to 3. In order to attract the third worker, the monopsonist must offer an hourly wage of $20 instead of $15. However, because the monopsonist cannot discriminate among its workers (and risk alienating them), it must offer the higher $20 wage to its two current employees. Hence, the monopsonist's costs from hiring the third worker are $60 (3 × $20), and the marginal cost from hiring the third worker is $30 ($60 − $30). The marginal cost of $30 exceeds the new market wage of $20 because the monopsonist must also pay its two current employees an hourly wage that is $5 higher than before.