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

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 

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

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 (AC_L) or supply of labour, determines the wage rate at which workers are paid

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

• The MC_L 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 

Wages are determined where MC_L is equal to MRP_L

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 (MRP_L) and supply of labour (AC_L)

  • 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 MC_L = MRP_L

  • This would provide an effective wage rate of W₂ and 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