AP® Microeconomics review sheet from Aim for Five (aimforfive.com/micro/units/5/5-4)
Unit 5 · Topic 5.4
5.4 Monopsonistic Markets
A monopsony is a market with only one buyer of a factor, such as the single large employer in a small town. To hire one more worker it must raise the wage for everyone, so its marginal factor cost is above the wage. It hires fewer workers and pays a lower wage than a competitive labor market would, which creates a deadweight loss.
Key terms
- monopsony
- wage maker
- marginal factor cost
- labor supply curve
- deadweight loss
What a monopsony is
A monopoly is the only seller. A monopsony is the only buyer. In labor markets, that means one employer hires almost all the workers of a certain kind in an area. Think of a mining company in a remote town, or a hospital that is the only place nearby that hires nurses.
The monopsony is a wage maker. It faces the whole upward-sloping market labor supply curve. To attract more workers, it has to offer a higher wage.
Why MFC is above the wage
Assume the firm pays all workers of a given type the same wage. Then to hire one more worker, it has to raise the wage for that worker and for everyone it already employs.
Example: 3 workers will work for $14 an hour, but a 4th will join only at $16. Total labor cost goes from 3 × $14 = $42 to 4 × $16 = $64. The 4th worker is paid $16, but the marginal factor cost is $64 − $42 = $22: the $16 wage plus $2 extra for each of the first 3 workers.
So the MFC curve lies above the labor supply curve, and it rises more steeply. For a straight-line supply curve, the MFC curve starts at the same point on the wage axis and rises twice as steeply. (This mirrors how a monopolist's MR lies below demand in 4.1.)
How many workers, and at what wage
Describe the graph this way. Wage on the vertical axis, quantity of labor on the horizontal. A downward-sloping MRP (labor demand) curve. An upward-sloping labor supply curve (S), which is also the average factor cost. An MFC curve starting at the same point as S and rising more steeply above it. Lm is below where MFC crosses MRP; Wm is on S directly below that crossing. The competitive outcome is where MRP crosses S, at a higher wage Wc and a larger quantity Lc.
- Quantity: hire where MRP = MFC. That's the profit-maximizing number of workers, Lm.
- Wage: go down from that point to the labor supply curve at Lm and read across to the wage axis. That's Wm, the lowest wage that attracts Lm workers. Don't read the wage off MFC or MRP.
Why it's inefficient
Compared with a competitive labor market, a monopsony hires fewer workers (Lm < Lc) and pays a lower wage (Wm < Wc). Workers are paid less than the value of what the last worker adds (Wm is below MRP at Lm).
Between Lm and Lc, there are workers who would add more to revenue (MRP) than the wage they'd accept (supply), but they aren't hired. The lost surplus is deadweight loss: the triangle between the MRP curve and the supply curve, from Lm to Lc.
A minimum wage can actually raise both wages and employment in a monopsony, if it's set in the right range. That's covered in 6.4.
Worked examples
Try each one yourself first, then open the solution.
- Example 1Calculator allowed
Monopsony hiring from a table
The only employer in a town faces this labor supply: 1 worker will work for $10 an hour, 2 for $12, 3 for $14, 4 for $16, 5 for $18 and 6 for $20. The MRP of each worker is $40, $34, $28, $22, $18 and $14. The firm pays all workers the same wage. (a) How many workers does it hire, and at what wage? (b) What would a competitive labor market produce?
Show the solutionHide the solution
- Step 1: Total labor cost = wage × workers: $10, $24, $42, $64, $90, $120.
- Step 2: MFC = change in total labor cost: $10, $14, $18, $22, $26, $30.
- Step 3: (a) Hire while MRP ≥ MFC. Worker 4: MRP $22 = MFC $22, so hire. Worker 5: MRP $18 < MFC $26, so don't. The firm hires 4 workers.
- Step 4: The wage comes from the supply schedule at 4 workers: $16, not the MFC of $22.
- Step 5: (b) A competitive market would hire until MRP equals the wage on the supply curve: worker 5's MRP is $18 and the supply wage for 5 workers is $18. So 5 workers at $18.
Answer: (a) 4 workers at $16 an hour. (b) 5 workers at $18 an hour. The monopsony hires fewer workers at a lower wage.
- Example 2Calculator allowed
Finding deadweight loss on a monopsony graph (classic trap)
On a monopsony graph (wage in dollars per hour on the vertical axis, number of workers on the horizontal), the labor supply curve starts at $2 and rises $1 for each worker. The MFC curve starts at $2 and rises $2 for each worker. The MRP curve starts at $20 and falls $1 for each worker. Find the monopsony's employment and wage, the competitive employment and wage, and the deadweight loss.
Show the solutionHide the solution
- Step 1: Monopsony quantity: MRP = MFC. MRP is 20 − L and MFC is 2 + 2L. They're equal when 20 − L = 2 + 2L, so 3L = 18 and L = 6.
- Step 2: Wage: read the supply curve at 6 workers: 2 + 6 = $8. The trap is reading $14 (where MFC and MRP meet) as the wage. That's the MRP of the 6th worker, not the pay.
- Step 3: Competitive outcome: MRP = supply. 20 − L = 2 + L, so L = 9, and the wage is 2 + 9 = $11.
- Step 4: Deadweight loss is the triangle between MRP and supply from 6 to 9 workers. At 6 workers, MRP is $14 and the supply wage is $8, a gap of $6. Area = ½ × (9 − 6) × 6 = $9 per hour.
Answer: Monopsony: 6 workers at $8. Competitive: 9 workers at $11. Deadweight loss: $9 per hour.
Common mistakes
- Reading the monopsony wage where MFC crosses MRP. That gives the quantity; the wage is on the supply curve below that point.
- Drawing MFC below the supply curve. For a monopsony, MFC lies above supply, because hiring one more worker means raising everyone's wage.
- Mixing up monopsony (one buyer) with monopoly (one seller).
- Shading deadweight loss between MFC and supply. It's between MRP and supply, from the monopsony quantity to the competitive quantity.
On the exam
- A typical question asks you to describe a correctly labeled monopsony graph and identify the number of workers and the wage, then compare them with a competitive labor market. Label MRP, S and MFC, and mark Lm and Wm.
- Table questions give the wage needed to attract each worker. Compute total labor cost and MFC first; the wage paid is always read from the supply schedule.
Connected topics
Videos
Check yourself
4 questions on 5.4 Monopsonistic Markets. Pick an answer to see if you got it, and why.
| Number of workers | Wage needed to attract this many workers | Marginal revenue product |
|---|---|---|
| 1 | $8 | $30 |
| 2 | $10 | $26 |
| 3 | $12 | $22 |
| 4 | $14 | $21 |
| 5 | $16 | $17 |
| 6 | $18 | $12 |
Hypothetical hourly data for a factory that is the only employer in a small town (a monopsony). It must pay the same wage to all of its workers.
What is the marginal factor cost of the third worker?
To maximize profit, how many workers will the firm hire, and what wage will it pay?
For this firm, the marginal factor cost of each worker after the first is higher than that worker's wage because
Suppose the government sets a minimum wage of $16 per hour. How does the firm's hiring change?
0 of 4 answered