A2 Economics – Perfect labour market and monopsony with a minimum wage

Currently doing Cambridge A Level revision courses for the Association of Cambridge Schools New Zealand (ACSNZ) and today we went through the labour market.

Marginal revenue productivity (MRPL) is a theory of wages where workers are paid the value of their marginal revenue product to the firm.

Perfect labour market The MRP theory outlined below is based on the assumption of a perfectly competitive labour market and the theory rests on a number of key assumptions that realistically are unlikely to exist in the real world.

• Workers are homogeneous in terms of their ability and productivity

• Firms have no buying power when demanding workers (i.e. they have no monopsony power)

• There are no trade unions (the possible impact on unions on wage determination is considered later)

• The productivity of each worker can be clearly and objectively measured and the value of output can be calculated

• The industry supply of labour is assumed to be perfectly elastic – see graph. Workers are occupationally and geographically mobile and can be hired at a constant wage rate

Like market structures we use the following to work out how many workers to employ.

MRPL = MCL (Marginal Cost of Labour)   where the revenue generated by employing an additional worker (MRPL) = the cost of employing that additional worker (MCL). The quantity of labour is Le and the wage We

Monopsony labour market A monopsony occurs in the labour market when there is a single or dominant buyer of labour. The buyer therefore is able to determine the price at which is paid for services. Unlike other examples we have looked at, in this situation we are now dealing with an imperfect rather than a perfectly competitive market. Like perfect labour market the monopsonist will hire workers where:   Marginal Cost of labour (MCL) = Marginal Revenue product of labour (MRPL)   Therefore it will use labour up to level of Lm which is where MCL=MRP. In order to entice workers to supply this amount of labour, the firm need pay only the wage Wm. (Remember that ACL is the supply of labour). You can see, therefore, that a profit-maximising monopsonist will use less labour, and pay a lower wage, than a firm operating under perfect competition. The labour market clears where S = D which is a quantity of Le and wage of We.

Monopsony market and minimum wage

A monopsony employer faces a supply curve ACL, a marginal cost of labour curve MCL, and a marginal revenue product curve MRP. It maximises profit by employing L* units of labour and paying a wage of Wm. The imposition of a minimum wage W min makes the dashed sections of the ACL (supply) and MCL curves irrelevant – the firm cannot pay wages below W min. The marginal cost curve is thus a horizontal line at W min up to Le2 units of labour. MRP and MCL now intersect at Le1 so that employment increases. Le is the output where the market clears (ACL = MRP) pre minimum wage – supply = demand..

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