Questions: Monopsony

Question 1

In a monopsony labor market, the firm pays a wage that is...

• A. Equal to the marginal revenue product of labor, as in competition
• B. Below the marginal revenue product of labor because the firm exploits its market power to set wages below the competitive level
• C. Above the marginal revenue product of labor because the firm must attract workers
• D. Determined entirely by worker preferences

Answer: (B)

A monopsonist maximizes profit by hiring until marginal revenue product equals marginal cost of labor (MCL), not the wage. Because MCL > w (hiring an extra worker requires raising the wage for all workers), the firm hires fewer workers at a lower wage than competition would produce. The gap between MRPL and the wage represents monopsonistic exploitation — the firm captures rents by paying workers less than their contribution to revenue. This is analogous to a monopolist charging above marginal cost in the product market.

Question 2

A moderate minimum wage increase in a monopsonistic labor market necessarily reduces employment.

• T. True
• F. False

Answer: False

This is one of the most counterintuitive results in labor economics. In a monopsony, the firm is already hiring below the competitive employment level. A binding minimum wage above the monopsony wage but below the competitive wage forces the firm to pay more but also flattens the marginal cost of labor curve — the firm no longer needs to raise wages for all workers when hiring one more. This can increase both the wage AND employment, moving toward the competitive outcome. This theoretical result has been central to interpreting Card and Krueger's empirical finding of zero or positive employment effects from minimum wage increases.

Question 3

What makes modern monopsony theory (Manning) different from the classical single-employer monopsony model?

Model answer: Classical monopsony requires a single employer (e.g., a company town). Manning's modern monopsony shows that monopsony power arises whenever employers face upward-sloping labor supply curves — which occurs due to search frictions (workers cannot costlessly find and switch to better-paying jobs), geographic immobility (workers cannot easily relocate), job differentiation (workers prefer certain employers for non-wage reasons), and imperfect information (workers do not know all available wages). These frictions give every employer some degree of wage-setting power, making monopsony a matter of degree rather than an all-or-nothing market structure.

This insight transforms monopsony from a rare special case (company towns) to a pervasive feature of labor markets. Evidence for pervasive monopsony power includes: job-to-job wage gains (workers who switch employers earn significantly more, implying they were underpaid before), the employment effects of minimum wages (consistent with monopsony predictions), concentration effects (more concentrated employer markets have lower wages), and the persistence of wage differences across firms for identical workers.