AQA A-Level Economics · Revision notes

4.1.6.4 The determination of relative wage rates and levels of employment in imperfectly competitive labour markets

Real-world labour markets are rarely perfectly competitive. A monopoly is a single seller. A monopsony is the mirror image: a single buyer. Just as a monopolist can push prices up, a monopsonist can push the prices it pays, including wages, down. This page covers how monopsony power, trade unions and imperfect information create imperfections in labour markets, and how a monopsony employer reduces both wages and employment.

Characteristics and conditions for a monopsony

A monopsony is a market with a single buyer. In practice, the term is used for any buyer with enough power to influence the price it pays. A market with a few dominant buyers is sometimes called an oligopsony.

For a monopsony to operate:

• One buyer must account for a large share of purchases in the market, whether of a product or of labour.
• Sellers must have few alternative buyers. A supplier that can easily sell elsewhere cannot be pushed into accepting a low price.
• Sellers find it hard to leave. Specialist skills, perishable products or long-term contracts tie them to the buyer.

Examples

• The NHS employs most of the UK's doctors and nurses, so it has considerable power over their pay.
• Large supermarkets buy a large share of the output of many farmers and food producers, who have few other routes to consumers.
• A dominant employer in a small town, where workers would have to move or commute a long way to work elsewhere.

How a monopsonist uses its power

In product markets, a monopsonist can negotiate lower prices from suppliers, insist on longer payment periods, or require suppliers to pay for promotions and packaging.

Key idea: In labour markets, a monopsony employer can pay a lower wage and employ fewer workers than a competitive market would. To hire one more worker, it would have to raise the wage for all its workers, so the extra cost of hiring is higher than the wage itself.

Reading the diagram. The supply curve of labour shows the wage needed to attract each number of workers. Because every worker must be paid the higher wage, the marginal cost of labour (MCL) lies above the supply curve. The monopsonist employs workers up to the point where MCL equals MRP, which is fewer than in a competitive market. It then pays only the wage on the supply curve needed to attract that number of workers, which is below the competitive wage.

Costs and benefits of monopsony

Evaluation: For the public sector, monopsony power can be a benefit to taxpayers. The NHS can negotiate lower prices for medicines than many individual buyers could. But holding down pay too far can lead to staff shortages, as workers leave for other sectors or other countries.

Public sector wage setting

The government is the largest employer in the UK, so it sets the pay of millions of workers, including nurses, teachers and members of the armed forces. Independent pay review bodies make recommendations, but the government decides.

Evaluation: Holding public sector pay down can save money, but it can also cause staff shortages and industrial action if pay falls behind the private sector.

Responses to monopsony power

• Regulation can limit the abuse of buying power. In the UK, the Groceries Code Adjudicator was set up in 2013 to oversee how the largest supermarkets treat their suppliers.
• Trade unions can counter an employer's monopsony power by bargaining collectively for higher wages.
• A minimum wage can raise pay in a monopsony labour market, and in some cases may even increase employment.

Other imperfections in labour markets

Trade unions

Unions bargain collectively on behalf of workers, which gives the sellers of labour some market power, so wages are no longer set purely by competitive market forces.

Key distinction: In a competitive market, a union that pushes the wage above equilibrium may raise pay for its members but reduce employment. Facing a monopsony employer, a union can raise both wages and employment by offsetting the employer's power.

Imperfect information

Workers may not know about vacancies or the pay offered by other employers, and employers cannot judge how productive a new worker will be before hiring them. As a result, workers may stay in lower-paid jobs and people doing similar work can be paid different wages. Firms may also rely on qualifications as a signal of ability.

Current labour market issues

• Zero-hours contracts and the gig economy. Flexible work suits some workers but leaves others with uncertain hours and income.
• Skills shortages in areas such as health care, construction and technology.
• The gender pay gap, the difference between average earnings of men and women.
• Migration, which affects the supply of labour in many sectors.
• Automation and artificial intelligence, which may replace some jobs and create others.
• Public sector pay disputes, as pay in some public sector jobs has fallen behind the private sector.

Key terms

Common mistakes

• Confusing monopsony with monopoly. A monopoly is a single seller; a monopsony is a single buyer.
• Assuming monopsony always harms consumers. Lower costs can be passed on as lower prices.
• Ignoring suppliers' alternatives. Monopsony power depends on sellers having few other buyers.
• Forgetting the employment effect. A monopsony employer pays less and also employs fewer workers.
• Treating all labour markets as competitive. Monopsony employers and trade unions change the outcome.

How this has been examined

In the AQA papers indexed on this site, this topic has appeared in four formats:

• 25-mark "Assess" essay — asked once (2022)
• 25-mark "Evaluate" essay — asked once (2023)
• 9-mark "Explain" data response — asked once (2020)
• 1-mark multiple choice — asked 3 times across 3 series (2018 to 2022)

Where this goes next

The competitive benchmark is covered in 4.1.6.3 The determination of relative wage rates and levels of employment in perfectly competitive labour markets. Trade unions are analysed further in 4.1.6.5 The influence of trade unions in determining wages and levels of employment, and the effect of a wage floor in a monopsony market in 4.1.6.6 The National Minimum Wage. The seller-side equivalent is covered in 4.1.5.6 Monopoly and monopoly power, and information problems more generally in 4.1.8.6 Market imperfections.