Why does a monopsony employer pay lower wages and hire fewer workers?

• →A monopsony is a labour market structure in which there is a single buyer of labour, giving that employer significant wage-setting power.
• →Because the monopsonist is the only employer in the market, it faces the entire upward-sloping labour supply curve, meaning whenever it wishes to recruit an additional worker it must raise the wage it pays to all existing workers.
• →The marginal cost of labour (MCL) rises faster than the average cost of labour (ACL, or the wage rate), so the MCL curve lies above the ACL curve. (see diagram below)
• →The profit-maximising monopsonist hires workers up to the point where MCL=MRP equals (marginal revenue product of labour), rather than where the wage equals MRPL as in a competitive market.
• →As a result, the quantity of labour employed is lower than the competitive equilibrium level. The monopsonist then pays only the wage that is necessary to attract that quantity of workers, which is read from the supply curve and below the competitive wage.
• →Therefore, the outcome is both lower employment and lower pay than would prevail under competitive conditions.
• →An example is a large supermarket chain that dominates employment in a rural area, able to suppress wages because workers have few alternative employers to turn to.
• →The key point to remember and include for examiners is that a monopsonist will restrict wages and the number of employees.

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This diagram shows the upward-sloping ACL (supply) curve and the steeper MCL curve positioned above it, alongside the downward-sloping MRPL curve. The critical elements are the intersection of MCL and MRPL (which determines the profit-maximising level of employment, Q_m), and the horizontal reading across to the supply curve to identify the monopsony wage (W_m), both of which sit below the competitive equilibrium wage and employment level. Students should label the competitive wage and employment clearly to demonstrate the suppression effect.

• →The ACL and MCL relationship: Because hiring one more worker forces the firm to raise wages for all existing workers, the MCL exceeds the ACL at every level of employment. Students must be able to explain why MCL lies above ACL, not simply state that it does.
• →Profit-maximising rule: The monopsonist maximises profit by equating MCL with MRPL — not by equating the wage with MRPL. Confusing these two conditions is the most common error in examination answers.
• →Wage determination from the supply curve: Once the profit-maximising level of employment is established, the wage is determined by reading across to the labour supply curve, not the MCL curve. This is the mechanism that produces the wage gap.
• →Deadweight welfare loss: The monopsonist's outcome creates an under-allocation of labour relative to the competitive equilibrium, resulting in a welfare loss to both workers (who receive lower wages) and society (due to fewer workers being employed).
• →Policy relevance — the minimum wage: A national minimum wage set between the monopsonist's chosen wage and the competitive wage can, in theory, raise both wages and employment simultaneously — a result that is unique to monopsony and counterintuitive compared with competitive labour market analysis.

This question tests understanding of wage and employment determination in imperfectly competitive labour markets — specifically the mechanism by which a single buyer of labour can exercise market power to reduce both pay and job numbers below the socially efficient outcome. The relevant specification content is AQA spec point 4.1.6.4 — the determination of relative wage rates and levels of employment in imperfectly competitive labour markets. Examiners are looking for students to move beyond simply stating that wages are lower and instead to demonstrate a logical chain: the shape of the MCL curve, the profit-maximising hiring rule, and the derivation of the wage from the supply curve.

Examined 4 times across AQA since 2018.

Three of the four appearances have been single-mark multiple-choice questions testing conceptual recognition, while the November 2020 extended question — the highest tariff recorded at 9 marks — required both a diagram and a developed explanation of the mechanism.