A monopsonistic market for labor | Microeconomics | Khan Academy

So let's continue with our conversation around factors of production for a firm, and we're going to focus on the labor market.

So we've already drawn axes like this multiple times, where our horizontal axis this is the quantity, quantity of labor that's being employed by a firm, and then the vertical axis this is our wage rate. This is where we're looking at the economics for a firm, and we're looking at how much labor is it rational for this firm to employ.

We've talked about the marginal revenue product multiple times. This is a view of how much incremental revenue can the firm get every time it brings on one more labor unit. We've talked about that we typically see it like a downward sloping line like this because you have diminishing returns. Every time you add one more labor unit, the marginal revenue product of that labor goes a little bit down. That's when you have diminishing return.

So there's marginal revenue products, and I'll be very particular this time, this is of labor. We could do a similar marginal revenue product of other factors like land or capital.

Now to change things up, in this video we're not just going to talk about a firm that operates in a perfectly competitive labor market. If we did, then its marginal factor cost would be whatever the market wage rate would be; it would be a horizontal line like this, so you would have a marginal factor cost of labor.

But we're not going to talk about a firm that's in a perfectly competitive labor market; we're going to talk about a firm that is a monopsony employer—a very fancy word. So it is a monopsony, not a monopoly—a monopsony.

Now, what does a monopsony mean? Well, you could almost view it as the reverse of what a monopoly is. A monopoly is when you have one seller—so one seller and many buyers, many, many buyers. That is a monopoly right over there.

A monopsony is when you have one buyer—one buyer and many sellers. You have many, many sellers. This right over here is a monopsony firm. In the context that we're talking about, we're talking about labor markets.

So this one, instead of saying one buyer, you could say this is one buyer of labor. You could say one employer and the sellers of laborers—well, a seller of labor, these are many potential workers—potential workers.

There are many real-world examples that approach monopsony employers. Let's say we're in a small town and there's only one hospital, so they're going to be the monopsony employers of healthcare workers—say nurses.

What's interesting about a monopsony employer is they're not just going to take whatever the wage rate is. They essentially have a supply curve for labor in that market. For example, in this market when wages are low, there's going to be a low supply of labor. Not many people are going to want to work for that hospital.

Then as wages go up, more and more and more people are going to want to work for that monopoly employer. This is our labor supply curve.

I'm going to ask you a question; I'm going to tell you right now it is a trick question. What is going to be the rational quantity for this firm to hire? Now you might be tempted to say, "Well, it's just the same thing; we would just want to keep hiring as long as our marginal revenue product of labor is higher than the cost of labor."

That would be true if you could afford to pay everyone a different rate. If this first unit of labor you can pay this someone this much, and then everyone that you hire, you have to just pay them a little bit more—but that's not the way that it typically works in the real world.

You often think about having whatever the wage is. If we decide that this is the quantity of labor that we want to bring on, you wouldn't pay this wage just to that incremental person; you would have to pay that wage to everyone.

To think about what is the rational quantity of labor to bring on for this firm, we would need to think—we need to calculate or at least visualize what the marginal factor cost of labor here—which is going to be different than our labor supply curve.

To help us visualize that, let me set up a little table here. So I'm just going to make up some numbers. So we're going to think about the quantity of labor; let's just go 0, 1, 2, 3, 4. Then let's think about the price of labor.

Let's say when the quantity of labor is one, the price of labor is three, and then it goes up. If we want to hire more people, the price of labor goes up to four, it goes up to five, it goes up to six, keeps going.

What would be the total cost of labor? Well, you could figure that out. If you hire one unit at three dollars per unit, one times three is three. Two units at four dollars per unit—remember you're going to have to pay everyone the same amount—so it's not like you can just pay this first person three dollars and only the second person four dollars, in which case this would be seven.

But if you're going to hire two units, you have to pay everyone four dollars, so your total cost is eight here.

For two times four, three times five, your total cost is fifteen. Your total cost here is twenty-four.

Now we could think about what is our marginal factor cost of labor. So when you bring on that incremental unit of labor, how much incremental cost are you taking on?

When you go from one to two units, your total cost goes from three to eight—so your marginal factor cost has gone up by five. This is plus five right over here.

When you go from two to three, your marginal factor cost—you went from eight to fifteen, so eight to fifteen you went up by seven. Again, this is because when you want to hire more people, you're going to have to pay more to attract those incremental people.

But you have to pay that higher rate to everyone, so you see that the marginal factor cost of labor is going up twice as fast as our labor supply curve.

Our labor supply curve, every incremental unit we're adding one here, every incremental unit we're adding two. We could see it again; to go from fifteen to twenty-four, you have to add nine, so our marginal factor cost of labor is nine.

Looking at this as an example, you see that your marginal factor cost of labor is going to go up at twice the slope of your labor supply curve.

So, your marginal factor cost of labor is going to look something like this—it’s going to go up twice as fast, marginal factor cost of labor.

Now, this might be ringing a bell; this might seem like what we studied in the past when we looked at a monopoly or an imperfect competitor firm. We talked about the demand for its goods and also talked about its marginal revenue, and the marginal revenue curve had twice the negative slope as the demand curve.

Here we see everything just flipped over because we're not now talking about revenue for the firm and marginal revenue for the firm; we are talking about costs for the firm. These are inputs for the firm.

But now what would be the rational wage rate, and what's the rational quantity of labor for this firm?

Now that we've done the marginal analysis, we would see that it's rational for the firm to keep bringing on more and more people as long as the marginal revenue product of labor for each incremental unit is higher than the marginal factor cost of labor for each incremental unit.

So it would keep hiring until you get to this point right over here. It would be rational for it to bring on this quantity of labor.

What would be the wage that it would pay? You might be tempted to just go right over here and say it would pay this wage. But remember, it doesn't have to pay this wage at this quantity of labor; the labor supply curve tells us that the market wage would be right over here.

So it would be paying this wage—it would be paying this wage right over here. This is something for you to maybe ponder on a little bit more.

But the big picture is, when we're dealing with a monopsony firm, it is the only person hiring in the market or something that's approaching a monopoly firm. It's going to have its own labor supply curve, and the way you think about what a rational quantity for it to hire is you'd think about the marginal factor cost of labor, which is going to go up at twice the slope.

Where that intersects the marginal revenue product well, that tells you the quantity, and then the labor supply curve will tell you the wage for that quantity.