Economics
Monopsony Power in Labor Markets
Quick fact
In a monopsony, the employer can pay workers less than the value of what they produce, and even a modest minimum wage can increase both wages and employment—the opposite of what standard theory predicts.
Why this is interesting
Imagine a town with only one large employer. If you need a job, you have almost no choice—so how does that shape your pay?
Read the full explanation
Understanding Monopsony Power in Labor Markets
A monopsony is a market with a single buyer. In the labor market, this means there is only one dominant employer for a certain type of work. Because workers have few alternatives, they accept lower wages. The employer faces an upward-sloping labor supply curve: to hire more workers, it must raise the wage for all existing workers, making the marginal cost of hiring an extra worker higher than the wage itself. The firm maximizes profit by hiring workers until the marginal cost of labor equals the marginal revenue product (the extra revenue a worker generates). This results in fewer workers hired and a wage lower than the competitive equilibrium.
A deeper explanation
The key mechanism is the employer's market power. In a competitive market, each firm takes the market wage as given and hires until the wage equals the marginal product. In a monopsony, the firm controls the wage. Because it must raise wages to attract more workers, the marginal cost of labor exceeds the wage. The profit-maximizing employment level is where the marginal cost of labor equals the marginal revenue product, which occurs at a lower employment level and a lower wage than in a competitive market. This explains why monopsony creates inefficiency: the firm hires fewer workers than socially optimal, and workers are paid below their marginal product. Monopsony power can arise from geographic isolation, specialized skills, or high switching costs. A minimum wage set between the monopsony wage and the competitive wage can raise both wages and employment, a result that surprises many people.