5.3.5: Monopsony and the Minimum Wage

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Learning Objective

1. Compare the impact of a minimum wage on employment in the case where the labor market is perfectly competitive to the case of a monopsony labor market.
2. Discuss the debate among economists concerning the impact of raising the minimum wage.

We have seen that wages will be lower in monopsony than in otherwise similar competitive labor markets. In a competitive market, workers receive wages equal to their MRPs. Workers employed by monopsony firms receive wages that are less than their MRPs. This fact suggests sharply different conclusions for the analysis of minimum wages in competitive versus monopsony conditions.

In a competitive market, the imposition of a minimum wage above the equilibrium wage necessarily reduces employment, as we learned in the chapter on perfectly competitive labor markets. In a monopsony market, however, a minimum wage above the equilibrium wage could increase employment at the same time as it boosts wages!

Figure 14.9 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. Now suppose the government imposes a minimum wage of$5 per hour; it is 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; the firm cannot pay those wages. Notice that 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. In the case shown in Figure 14.9, that occurs at L2. The firm thus increases its employment of labor in response to the minimum wage. This theoretical conclusion received apparent empirical validation in a study by David Card and Alan Krueger that suggested that an increase in New Jersey’s minimum wage may have increased employment in the fast food industry. That conclusion became an important political tool for proponents of an increase in the minimum wage. The validity of those results has come under serious challenge, however, and the basic conclusion that a higher minimum wage would increase unemployment among unskilled workers in most cases remains the position of most economists. The discussion in the Case in Point summarizes the debate.

Key Takeaways

• In a competitive labor market, an increase in the minimum wage reduces employment and increases unemployment.
• A minimum wage could increase employment in a monopsony labor market at the same time it increases wages.
• Some economists argue that the monopsony model characterizes all labor markets and that this justifies a national increase in the minimum wage.
• Most economists argue that a nationwide increase in the minimum wage would reduce employment among low-wage workers.