Determining Wage Rates: Imperfectly Competitive Labour Markets (AQA A Level Economics): Revision Note

Exam code: 7136

Lorraine

Written by: Lorraine

Reviewed by: Steve Vorster

Updated on

The Factors that Contribute to Imperfections in a Labour Market

  • A perfectly competitive labour market is a theoretical construct

  • All labour markets face some level of imperfection

Diagram: Reasons for Imperfections in the Labour Market 

Diagram showing causes of imperfections in the labour market: monopsony power, imperfect information, and trade unions connected to a central oval.
Imperfections cause wages to differ from what they would be in a perfectly competitive equilibrium 
  • In reality, labour market wages are not always determined according to the Marginal Revenue Product (MRP) theory

  • Firms and workers have some degree of influence over wage setting

  • The less competition in the labour market, the more power employers have in setting wages 

Explaining the Imperfections in the Labour Market


Imperfection


Explanation 

Monopsony 

  • A monopsony occurs when there is a single employer of labour in a market, giving the employer considerable labour market power to set wages and employment

    • This suppresses wages in the relevant market and may lead to industrial action and ongoing labour issues in the industry

    • E.g. The NHS is the main employer of doctors and nurses in the UK and due to a lack of competition for their labour, the government has been able to suppress their wages for many years

Trade union

  • A trade union is an organisation that represents people who work in a particular industry to protect their rights through collective bargaining

  • Trade union activity can cause wages to be set above a competitive market equilibrium rate

    • E.g. The British Medical Association (BMA) is the UK trade union for doctors and is  negotiating for better pay (2023/24)

Imperfect information

  • Imperfect information in the labour market occurs when employees or employers do not have the same level of information about employment, skills, or wages to make informed decisions

  • It can lead to wage discrimination  or mismatches between skills and job requirements

  • Depending on the type of imperfection, wage levels may end up being higher or lower than they would be if the infromation was perfectly accessible

How Monopsony Power Impacts Relative Wage Rates & Employment Levels

  • In a monopsony labour market, there is only one buyer of labour and wages are the same for all workers

  • This is often a single large employer, which gives them significant market power

  • The employer has the ability to influence both the wage rate and the level of employment

  • The average cost of labour (ACL) or supply of labour, determines the wage rate at which workers are paid

  • The marginal cost of labour (MCL) is greater than ACL because the monopsonist has to increase the wage rate for all workers when hiring just one extra worker

  • The MCL curve includes the salary of the additional worker and also the extra money paid to all of the other workers

    • This causes the marginal cost to be greater than the average cost

Graph: Wages & employment in a monopsony labour market 

Graph showing labour market equilibrium with wage rate on the vertical axis and employment on the horizontal axis; includes supply, demand, and marginal cost.
Wages are determined where MCL is equal to MRPL

Diagram analysis

Wage and employment levels in a competitive market

  • In a competitive labour market, wages and levels of employment are determined by the intersection of demand (MRPL) and supply of labour (ACL)

    • This provides a wage rate of W1 and level of employment equal to E1

Monopsonists reduce wage and employment levels

  • The profit maximising level of employment for a monopsonist occurs when the MCL = MRPL

    • This would provide an effective wage rate of Wand level of employment equal to E2

  • However, due to their market power, wages can be set at a lower level

    • The monopsonist sets an effective wage rate of W3 at the employment level of E2

  • By setting wages below the competitive level, the employer can reduce its labour costs and increase its profits

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Lorraine

Author: Lorraine

Expertise: Economics Content Creator

Lorraine brings over 12 years of dedicated teaching experience to the realm of Leaving Cert and IBDP Economics. Having served as the Head of Department in both Dublin and Milan, Lorraine has demonstrated exceptional leadership skills and a commitment to academic excellence. Lorraine has extended her expertise to private tuition, positively impacting students across Ireland. Lorraine stands out for her innovative teaching methods, often incorporating graphic organisers and technology to create dynamic and engaging classroom environments.

Steve Vorster

Reviewer: Steve Vorster

Expertise: Economics & Business Subject Lead

Steve has taught A Level, GCSE, IGCSE Business and Economics - as well as IBDP Economics and Business Management. He is an IBDP Examiner and IGCSE textbook author. His students regularly achieve 90-100% in their final exams. Steve has been the Assistant Head of Sixth Form for a school in Devon, and Head of Economics at the world's largest International school in Singapore. He loves to create resources which speed up student learning and are easily accessible by all.