Monopsony employers and minimum wages

In this video, we're going to review what we've already learned about monopsony employers that we've covered in a previous video. But then we're going to add a twist of adding a minimum wage and see what happens. And it's actually interesting; it's actually somewhat counter-intuitive.

So just as a bit of a review, when we're talking about a monopoly, generally we're talking about one buyer and many, many sellers. So when we're talking about a monopsony employer, that one buyer is the one employer that might be, say, in a small town. They’re the big industry there and they're the only person that a lot of folks could work for. And then the many sellers, well, those are all of the workers, the people who are selling their labor.

We've already talked about the rational quantity of labor that that monopsony employer would hire. So you have your wage on that axis, that's in dollars; you have your quantity of labor on the horizontal axis. We can think about our downward sloping marginal revenue product of labor. Every incremental unit of labor, you might get a little bit lower and lower marginal revenue from that input. So this is our marginal revenue product, or MRP. We could call it marginal revenue product of labor because you could also have marginal revenue product of capital or of land, or other factors of production, but we're talking about employment here.

Then we could think about the marginal factor cost. Now, this is a significant difference between a monopsony employer and an employer in a perfectly competitive labor market. If we were dealing with a perfectly competitive labor market, then the employer would just have to pay the market wage. The marginal factor cost, the amount that they would have to pay for an incremental unit of labor, would just be constant, whatever the market wage of labor is. So that would be the marginal factor cost, and it would be rational if this was not a monopsony employer to just keep hiring more and more, as long as the marginal revenue product is higher than the marginal factor cost curve, which is set by the market wage rate.

So it would produce, or it would hire, I should say, this quantity of labor. But for a monopsony employer, you could view them as, in a lot of ways, they are the only buyer in the labor market. So we could think about a supply curve of labor just for their market or just for their industry, or just for them really. And so it could look something like this: this is the supply of labor, supply of labor.

And we've talked about that this is not the marginal factor cost curve for the monopsony employer because even though that first person might be willing to work for this wage, and then the very next unit of labor might be willing to work for a slightly higher wage, if you have to give that slightly higher wage to the second person, we assume that whatever wage they give to one person they have to give to everyone.

In this video, we're going to review what we know about a monopsony employer, and then we're going to add a twist that deals with minimum wages, which are going to be a little bit counter-intuitive. So just as a review: a monopsony in general is when you have one buyer and many sellers, and a monopsony employer is the situation where that one buyer, they’re the buyer of labor, of that factor of production. So you have one employer and then the many sellers. These are the sellers of labor, the people who are providing their own labor, so these are all of the workers.

And we've already studied this in previous videos, but I will review it right now. We can draw our classic axes where you have your wage rate here in dollars on the vertical axis; you have your quantity of labor right there on the horizontal axis. We can think about our marginal revenue product of labor curve. So every incremental unit of labor the firm gets a little bit less benefit measured by revenue; so less and less and less revenue. And so this is marginal revenue product, this is the marginal revenue product of labor because we're talking about labor markets.

If this was another factor of production, it would be marginal revenue product of capital or of land or whatever else. Then we could think about the marginal factor cost. If this were not a monopsony employer, then the marginal factor cost would just be the market wage rate, so it would look something like that.

And we've already seen this if this was an employer in a perfectly competitive labor market. But this is not an employer in a perfectly competitive labor market; they're the only employer in this small town. They're the big industry, and so they're going to have their own unique labor supply curve. So it might look something like this: labor supply of labor.

You might be tempted, and we thought about this in a previous video, to say, "Hey, this is going to be the marginal factor cost curve of labor." Because you say, "Well, you know that first person is willing to work for that much; the second person is willing to work for that much," or the second unit of labor. But remember we said, or we're making the assumption, that even a monopsony employer, if it pays, if it has to raise the wage to get that second unit of labor, has to raise the wage for everyone.

So when it goes further and further up the supply curve as it hires more and more and more, it's not just paying the incremental amount to that incremental person; it has to pay to everyone. So its marginal factor cost is going to go up twice as fast. So the marginal factor cost curve is going to look something like this: it's going to look like this, our marginal factor cost curve, and this is of course when we're dealing with a monopsony employer.

So what is the rational quantity of labor for this firm to hire? Well, it's going to keep hiring as long as, on the margin, every incremental unit of labor it brings on it gets more revenue than it has to incur in cost. So as long as the marginal revenue product is higher than the marginal factor cost, it keeps hiring all the way until this point when they're equal. So it would hire this quantity of labor.

And what is the wage it would have to pay? Sometimes we just instinctively go back to this dot; we just want to go horizontally because we're thinking about equilibrium prices and quantities. But remember, at this quantity, this is not the wage up here; the wage is defined by the supply curve. So this is the wage that the firm would pay.

Now, I'm going to add a twist. What do you think would happen if this town said, "All right, well this employer has too much power here and we think they should pay higher wages?" What do you think would happen if the town increased the or enacted a minimum wage that is higher than W sub 1? And actually, let's assume a situation where the town enacts a minimum wage that's right here at W sub 2. What does the marginal factor cost curve now look like for this monopsony employer?

And now what would be the rational quantity of labor to employ? Pause this video and think about it. Well, in a world where the government sets a minimum wage, well then it starts to feel, at least graphically, a lot more like a competitive labor market. Although this isn't due to market forces; this is due to just some type of government law.

But then the monopsony employer will no longer have its own supply of labor curve like this, and it would no longer have this upward-sloping marginal factor cost curve. I'll call this marginal factor cost curve 1. Now the government has defined the wage, so no matter how many people they hire, they're going to pay that same wage. So the marginal factor cost is now going to be a horizontal line at that wage that the government set. So the marginal factor cost sub 2, and this is due to a minimum wage.

Now, what is the rational quantity to hire? Well, like always, it's rational to keep hiring as long as, for every incremental unit of labor, your marginal revenue product is higher than your marginal factor cost. So they keep hiring all the way until this point, and so this is the rational quantity for them to hire, let's call that Q sub 2. We already know the wage; that's the minimum wage that the government has set.

Now, something very counter-intuitive has happened. Now all of a sudden, it's rational for the firm to hire more people. The reason why I say this is counter-intuitive: if I'm just running some type of a business and all of a sudden I have to pay higher wages, well I might say, "Well gee, I can't afford to pay as many people, so I'm not going to—I actually might have to reduce my employment."

And that might be the case if we're dealing with other types of labor markets, if I'm not a monopsony employer. But at least theoretically, based on all the assumptions we've made—and we can debate on how transferable this is to the real world—if you have a monopsony employer, what this did is actually caused the employer to hire more.

You might say, "Why is that?" Well, now the employer is paying the same wage regardless of how many people they hire. Before, every incremental person they hired, every incremental unit of labor, it raised the wage for everyone. So in some ways, or in a very real way, this made it rational for the firm to hire more.

Now, that doesn't mean that the firm is better off in this situation; it's just splitting the marginal revenue product differently between the firm and the employers. In the old situation, the firm was able to capture everything above the wage line and below the marginal revenue product line. So the firm was able to capture all of that, while in this new world, the firm is capturing everything above the wage line and below the marginal revenue product line.

So it is a different area. But the other thing to keep in mind is I picked a very particular wage that would cause this horizontal marginal factor cost curve to intersect the marginal revenue product curve right where the marginal revenue product curve intersects the supply of labor curve. I could have picked another wage.

So the government could have overshot, and it could have said, "Hey, we're going to raise the minimum wage up here to W sub 3." And then what would happen? Well then your marginal factor cost curve would be up here, marginal factor cost sub 3, and the rational quantity to hire would actually go down, which is a little bit more intuitive for what would happen when you enact a minimum wage.

But at least theoretically, when you're dealing with a monopsony employer, there could be a situation where forcing the wages up could cause the employer to hire more, which is counter-intuitive.