Question

Draw a graph illustrating what would happen to the labor supply and to the equilibrium wage in a monopsony market facing a binding minimum wage. Detail whether these quantities would increase or decrease and highlight on your graph the new MC curve.

Answer 1

Wages are lower in monopsony compared to similar competitive labor markets. In a competitive market, Wages = MRP, however, in the case of monopsony, wages are less than MRP. In a monopsony market, a minimum wage above the equilibrium wage would increase employment as well as boost wages.

Please refer to the below graph which shows a monopsony employer that faces a supply curve, S, from which we derive the marginal factor cost curve, MFC. The firm maximizes profit by employing Lm units of labor and paying a wage of $4 per hour. The wage is below the firm’s MRP.

The government, let's suppose, now imposes a minimum wage of $5 per hour so it becomes now illegal for firms to pay less. At this minimum wage, L1 units of labor are supplied. To obtain any smaller quantity of labor, the firm must pay the minimum wage. That means that the section of the supply curve showing quantities of labor supplied at wages below $5 is irrelevant and the firm cannot pay those wages. The section of the supply curve below $5 is shown as a dashed line. If the firm wants to hire more than L1 units of labor, however, it must pay wages given by the supply curve.

Marginal factor cost is affected by the minimum wage. To hire additional units of labor up to L1, the firm pays the minimum wage. The additional cost of labor beyond L1 continues to be given by the original MFC curve. The MFC curve thus has two segments: a horizontal segment at the minimum wage for quantities up to L1 and the solid portion of the MFC curve for quantities beyond that.

The firm will still employ labor up to the point that MFC equals MRP. As shown in the below graph it occurs at L2. The firm thus increases its employment of labor in response to the minimum wage.

A monopsony employer faces a supply curve S, a marginal factor cost curve MFC, and a marginal revenue product curve MRP. It maximizes profit by employing Lmunits of labor and paying a wage of $4 per hour. The imposition of a minimum wage of $5 per hour makes the dashed sections of the supply and MFC curves irrelevant. The marginal factor cost curve is thus a horizontal line at $5 up to L1units of labor. MRP and MFC now intersect at L2 so that employment increases.