(THE LOST EPISODES) Monopsony Factor, Perfectly Competitive Output - YouTube

What if the firm is perfectly competitive in the OUTPUT market, such that it is one

of a very large number of producers who all sell the identical product, but is a MONOPSONY

in the resource market -- i.e., the sole buyer of the resource?

If you are the monopsonistic hirer of, for example, labor, then you are the only employer

in this market (this could occur if there was just a single employer in a small, isolated

town).

You are no longer a competitive hirer of labor, subject to the price determined by the overall

supply of and demand for Labor in the market -- that is, you are no longer a price taker

when it comes to the wage that you pay the workers.

You are no longer facing the perfectly elastic supply of labor seen in the competitive resource

market; no, as the only buyer of labor (i.e., the only employer), anyone who wants to work

will work for you -- the firm sees the entire supply of labor available in this market.

What does it mean, that the supply of labor is now upward-sloping, rather than horizontal?

Before, in the competitive labor market, wage was constant, and the employer could hire

as many workers as he/she wanted at the "going wage."

Now, each time the employer wants to attract more workers, that employer will need to offer

a better price -- i.e., a higher wage.

Let's look at an example: let's say that you are the employer.

If you pay nothing, no one is willing to work for you, so suppose that you offer to pay

two dollars an hour.

At a wage of two dollars, only one person is willing to work for you.

How do you attract more employees?

Offer a better wage!

When you offer four dollars an hour, two people are willing to work for you; at a salary of

six dollars an hour, 3 people are willing to work for you, and so on.

The upward-sloping supply shows that, at higher wages, more labor will be supplied (there

is a concept of a "backward-bending" supply of labor, but I'm not going to get into that

in this episode).

OK, so where was I?

We wanted to know, if a firm is competitive in the output market, and has monopsony power

in the labor market, how many workers will that firm hire, and at what wage?

Before I get into that, let me do a quick re-cap of the firm that is perfectly competitive

in BOTH input and output, so that we can make some comparisons later.

If you remember, we started out with just the workers and the output.

From there, because we know that marginal product is the change in the output when the

resource (labor, in this case) changes, we can look at the change in output in the table,

each time we hire another worker.

Once we knew MP, we were able to establish the market value of that Marginal Product

by taking Marginal Product times Price.

If the market-determined price of output is constant (this is a competitive product market,

remember) at, say, two dollars, then we can easily calculate the Value of the Marginal

Product by taking Price times Marginal Product.

And because the output market is competitive, remember also that Price equals Marginal Revenue.

This means, of course, that Price times Marginal Product is the same as Marginal Revenue times

Marginal Product, or the Value of the Marginal Product equals Marginal Revenue Product, so

we can enter the VMP figures into the MRP column.

In the perfectly competitive output and factor market scenario, we also found that the wage

is constant (determined by labor market forces), let's say, at eight dollars.

A constant wage also meant that the added cost of bringing in another worker (the "Marginal

Factor Cost") would be constant at that wage, since each worker is hired in at that same

wage.

So in the end, with perfect competition in both the output and factor markets, the profit-maximizing

rule (Marginal Revenue Product equals Marginal Factor Cost) is satisfied at four workers,

who each get paid a wage of eight dollars.

But we aren't dealing with perfect competition in both the factor and output markets, are

we?

When I started this episode, I said that we want to think about a perfectly competitive

output market, but a monopsony resource market.

That means we'll have to back up a bit -- if we go back to the original data, the labor,

total product, and marginal product will be unchanged by this shift in market structures

(the product figures are unrelated to the structure of the market).

And because we were looking at perfectly competitive output previously, and we are STILL looking

at perfectly competitive output, the output price (constant at two dollars, in this case),

Value of the Marginal Product, and Marginal Revenue Product are the same as they were

before.

The difference comes in when we shift from a perfectly competitive factor market to a

monopsonistic factor market -- we change from having a small firm facing a perfectly elastic

supply of labor, and therefore a constant wage, to having a single large firm facing

the entire industry supply of labor, where wage will rise as the firm tries to attract

more labor.

In the data table, this means that rather than having a wage that is constant at eight

dollars, the wage now rises, the more labor is hired (remember, to get more employees

to work for you, you will need to offer a higher wage).

Because the wage rises as more labor is hired, the total cost of hiring the labor (wage,

w, times L, the number of workers) rises much more quickly than in a competitive market,

where wage was constant.

This, in turn, alters Marginal Factor Cost (defined as the change in cost over the change

in the resource, labor) substantially -- the Marginal Factor Cost values end up being higher

than the wages.

Why is this?

Well, in this model the firm must pay all of its employees the same wage.

Why does this matter?

Think about it: the employer cannot simply lure in a new employee with a higher wage;

all of the other employees' wages must be raised to match.

Take the data in our table, for example: the firm can hire a single employee at a wage

rate of two dollars, for a total cost of two dollars.

If the firm wants to attract more workers, it will need to offer better wages.

The firm can hire two workers by offering a wage of for dollars, but because it must

pay BOTH employees the four dollar wage, the total cost is now eight dollars.

So the added cost of the second worker, or the Marginal Factor Cost, is six dollars -- the

four dollar added salary, plus a two dollar raise for the existing employee.

To get three workers, the firm will have to offer a wage of six dollars, raising the total

cost of labor to eighteen dollars.

The third worker, therefore, added ten dollars to the cost.

As each new worker is added, you can see that the Marginal Factor Cost of that worker is

greater than the wage paid; the added cost is not only the new employee's salary, but

also the raises that must be given to all of the existing employees.

Ultimately, the profit-maximizing hiring decision for the monopsonist occurs where Marginal

Revenue Product equals Marginal Factor Cost, somewhere between three and four workers.

To re-cap, because of the perfectly competitive output market, Value of the Marginal Product

equals Marginal Revenue Product; because of monopsony in the factor market (there is a

single buyer of the resources), the firm faces the industry supply of labor, and Marginal

Factor Cost of labor will lie above supply.

Choosing to hire where Marginal Revenue Product equals Marginal Factor Cost, "L*" workers

will be hired (less than with perfect competition), and the employer will drop down to the supply

curve of labor to see what wage the sellers of labor (i.e., the employees) are willing

to accept.

Because w* is LESS that the market value of the output added by this last worker hired,

there is MONOPSONISTIC EXPLOITATION of labor.

In the end, the monopsonistic employer hires fewer workers, and at a lower wage, than a

perfectly competitive hirer.

NEXT TIME: Monopsony factor market, Monopoly output market.