AQA Specification focus:
‘How various factors such as monopsony power, trade unions and imperfect information contribute to imperfections in a labour market; in a monopsony labour market, the employer can use market power to reduce both the relative wage rate and the level of employment below those that would exist in a perfectly competitive labour market; the use of relevant diagrams is expected.’
In imperfect labour markets, factors such as monopsony power, trade unions, and imperfect information influence wage determination and employment outcomes, diverging significantly from the predictions of perfect competition models.
Monopsony Power in Labour Markets
A monopsony occurs when there is a single dominant employer in a labour market. Unlike in perfect competition, where many firms compete for workers, a monopsony gives the employer significant control over both wage levels and employment conditions.
Monopsony: A labour market situation where there is a single or dominant employer, giving them market power over wage determination and employment.
In a monopsony:
The employer faces the market supply curve of labour, which is upward sloping.
To hire additional workers, the firm must offer higher wages.
However, higher wages must be paid to all existing workers, increasing marginal cost of labour (MCL) faster than the average wage.
This leads to a situation where the firm employs fewer workers and pays a lower wage than in perfect competition.
Monopsony in a labour market with MRP(MRPL), SL, and MCL. The monopsonist hires where MCL = MRP (employment L) and pays wage w from the supply curve, below the competitive wage w′ at L′. This visual supports the syllabus point that monopsony power depresses both wages and employment. Source
Wage and Employment in Monopsony
In perfectly competitive labour markets, wages are set by the intersection of labour demand (marginal revenue product of labour) and labour supply. In contrast, in a monopsony:
The wage is set where the MCL curve intersects the demand for labour.
The wage paid is below the competitive equilibrium, and employment is restricted.
The key effects of monopsony:
Lower wages than competitive levels.
Reduced employment, harming overall labour market efficiency.
Wage exploitation, since workers are paid less than their marginal revenue product.
Trade Unions and Their Role
Trade unions exist to counteract employer power, especially in monopsonistic or imperfectly competitive markets. By collective bargaining, unions can raise wages and alter employment outcomes.
Trade Union: An organised association of workers formed to protect and further their rights and interests, particularly in wage negotiations and working conditions.
In a monopsony, union activity can:
Push wages closer to competitive equilibrium levels.
Increase both wages and employment, unlike in a competitive market where higher wages usually reduce employment.
Reduce the degree of wage exploitation.
However, if union demands exceed productivity levels, firms may reduce employment or relocate production, showing the balancing act unions must maintain.
In a monopsony, a union-negotiated wage floor can raise pay and increase employment if set within the range that lowers marginal hiring cost.
Bilateral monopoly: a union on the supply side and a monopsony on the demand side. The negotiated wage can move the outcome between Wm (monopsony) and Wu (union), with employment determined where DL meets the relevant marginal cost of labour. This diagram focuses on wage and employment effects of unions in an imperfectly competitive labour market. Source
Imperfect Information in Labour Markets
Imperfect information refers to situations where workers or employers lack complete knowledge of wages, job conditions, or available opportunities.
Imperfect Information: A condition in which either workers or employers do not have full or accurate knowledge of labour market conditions, wages, or job availability.
Impacts of imperfect information include:
Workers may accept jobs below their skill level or at lower wages than available elsewhere.
Employers may struggle to fill vacancies due to lack of information about worker availability.
Increased labour market frictions, leading to inefficient allocation of resources.
These frictions mean that even without monopsony or union involvement, labour markets rarely operate at the theoretical equilibrium predicted by perfect competition.
Interaction Between Monopsony, Unions, and Imperfect Information
The three factors are interconnected in shaping labour market outcomes:
Monopsony power allows employers to suppress wages.
Trade unions can counteract monopsony by raising wages and employment.
Imperfect information makes it harder for workers to move to better opportunities, strengthening monopsony effects.
Bullet point overview:
In monopsony without unions → low wages and restricted employment.
In monopsony with unions → wages rise, employment may also increase.
With imperfect information → monopsony power is reinforced as workers lack alternatives.
Diagrams and Economic Reasoning (without illustration)
Though diagrams are required in the exam, the reasoning behind them can be summarised textually:
Competitive market: Wage = MRP of labour; employment at supply-demand equilibrium.
Monopsony market: Employment determined where MCL = MRP, wage set below equilibrium.
Unionised monopsony: Union bargaining can shift wage closer to equilibrium, raising both wage and employment.
These shifts highlight the impact of imperfect competition in labour markets, as real-world conditions rarely reflect perfect competition.
FAQ
Large supermarket chains, major tech firms, and national health services can act as monopsonists by being dominant employers in specific sectors or regions.
For example, the NHS in the UK employs a vast proportion of healthcare workers, giving it significant wage-setting power. Similarly, mining companies in isolated towns often provide the majority of local employment opportunities, limiting worker alternatives.
When workers lack information about alternative job opportunities, they are less likely to leave low-paid employment.
This strengthens monopsony power because:
Employers face less competitive pressure to raise wages.
Search costs discourage mobility, even when better jobs exist.
Employees may underestimate their own productivity and accept lower pay.
In competitive markets, union demands for higher wages often reduce employment, as firms can replace workers or hire fewer at higher costs.
In monopsony, however, unions can raise both wages and employment because the monopsonist’s wage suppression is corrected. By negotiating closer to competitive levels, unions can improve labour outcomes without necessarily reducing jobs.
While unions can counteract low wages, excessive demands may cause distortions.
Potential drawbacks include:
Wage levels being pushed above productivity, risking unemployment.
Reduced investment if labour costs rise too sharply.
Employers relocating or automating, reducing long-term employment opportunities.
For workers, imperfect information may mean settling for lower wages or poor working conditions.
For employers, it can mean:
Difficulty recruiting skilled labour due to limited visibility of available workers.
Longer vacancies, which reduce productivity.
Higher training costs if mismatched hires are made.
This dual effect can worsen inefficiencies across the labour market.
Practice Questions
Explain why a monopsonist in a labour market is able to set wages below the level that would exist in a perfectly competitive labour market. (3 marks)
1 mark for identifying that the monopsonist faces the market supply curve of labour and must increase wages to attract additional workers.
1 mark for recognising that the marginal cost of labour (MCL) lies above the average wage due to needing to raise pay for all existing workers.
1 mark for explaining that the monopsonist therefore hires fewer workers and sets a wage below the competitive equilibrium where supply meets demand.
Using a diagram, explain how the introduction of a trade union can affect wages and employment in a monopsonistic labour market. (6 marks)
Up to 2 marks for a correctly labelled diagram showing:
Monopsony equilibrium (where MCL = MRP, with wage set below competitive level).
Union-imposed wage floor raising pay closer to competitive equilibrium.
1 mark for explaining that in monopsony, a union can increase both wages and employment, unlike in perfect competition where higher wages often reduce employment.
1 mark for identifying that the union wage can reduce wage exploitation by aligning pay closer to the marginal revenue product of labour.
1 mark for recognising that the exact effect depends on the level of the union wage demand (if too high, employment may fall).
1 mark for overall evaluation/understanding of the interaction between monopsony and trade union power.
