Impact of Increased Labor Productivity in Monopsony and Perfectly Competitive Labor Markets
In a perfectly competitive labor market, there exists a large number of employers and workers. The sheer size of this market prevents any single employer or worker from influencing the prevailing wage rate, and information is assumed to be perfect. Both employers and workers possess comprehensive knowledge about job opportunities, market rates, and skill levels among the labor force, which are also considered to be identical.
Moreover, perfect labor mobility is a key characteristic, enabling workers to transition freely between jobs and locations in search of employment opportunities. This exceptional occupational and geographical mobility ensures that the wage rate is determined solely by the forces of supply and demand in the labor industry, as depicted in the classic supply and demand graph 1a.
As a firm operating within this competitive labor market, they must adhere to the prevailing market wage rate when hiring workers. Consequently, the firm's supply curve in this context is perfectly elastic, signifying that the company can employ any number of workers at the established market wage rate without affecting its labor costs. Since the wage rate is constant, hiring additional workers does not change the cost per worker for the firm. As a result, the marginal cost of hiring one more worker is identical to the average cost per worker already employed. This leads to a unique situation where the marginal cost of the firm equals the average cost, which is also equal to the supply curve as shown in Figure 1b.
In a monopsony labor market, there is only one major buyer of labor, usually a large employer, which grants them considerable market power and the ability to set wages, making them a wage maker. This unique position allows the employer to negotiate and dictate lower wage rates compared to what would prevail in a more competitive labor market.
The dominance of the single employer is reinforced by imperfect information in the market. Often, the employer possesses superior knowledge of the workload, skill requirements, and labor market conditions, giving them an advantage in wage negotiations. On the other hand, the workers may have limited access to information about prevailing wage rates and alternative job opportunities, which weakens their bargaining position.
As a consequence of the employer's market power and information advantage, wages tend to be kept at a relatively lower level than what would be seen in a more competitive setting. The workers may face limited job options and reduced mobility due to the lack of alternative employers, allowing the monopsonistic employer to maintain lower wage levels.
The supply curve in a monopsony represents the quantity of labor that workers are willing to offer at various wage rates. Unlike in a perfectly competitive labor market, where the firm faces a horizontal supply curve (perfectly elastic), the supply curve in a monopsony is upward-sloping. As the wage rate increases, more workers are motivated to enter the labor market, reflecting the standard upward-sloping supply curve. The employer has significant market power and can set the wage rate lower than what would prevail in a more competitive labor market. In a monopsony, hiring additional workers requires the employer to increase the wage rate not just for the new worker but also for all existing workers. Hence, the supply and marginal cost curves in a monopsony diverge as shown in Figure 2.
The demand for labour for both a perfect competitive labour market and monopsony can be explained through marginal revenue product (MRP) theory. The theory explains how firms determine the optimal quantity of labor to employ based on the additional revenue generated by each additional unit of labor.
The Marginal Revenue Product (MRP) is the additional revenue a firm earns from hiring one more unit of labor, taking into account both the increase in output (MPL) and the marginal revenue (MR) generated by that output. It is calculated by multiplying the Marginal Product of Labor (MPL) by the Marginal Revenue (MR).
The MRP theory states that firms in competitive and non-competitive markets will maximize their profits by hiring labor up to the point where the MRP is equal to the wage rate. At this level of employment, the additional revenue generated by hiring one more worker (MRP) is equal to the additional cost of hiring that worker (the wage rate). If MRPL > wage rate, the firm benefits from hiring more workers as the additional revenue generated exceeds the additional cost (wages). If MRPL < wage rate, the firm should reduce its workforce as the additional cost of hiring workers exceeds the additional revenue generated. Thus, by using the MRP theory, firms can make rational and optimal decisions regarding labor utilization, ensuring they hire the right number of workers to maximize their profits based on prevailing market conditions.
As a profit maximising firm, both markets will hire labour when MRPL(DL) = MC. Figure 3a, shows the equilibrium labor quantity for a perfectly competitive labour market firm. The market wage rate (W1) intersects the firm's labor demand curve. At this wage rate, the firm hires QL1 units of labor.
The monopsonist employer determines the wage rate (W) at which it wants to hire workers. The firm hires QL1 units of labor, where the firm's labor demand (MRPL) intersects with the marginal costs (MC). The monopsonist employer has the power to set the wage rate (W) based on its profit-maximizing decision. The wage rate,W1 is determined by the point where the monopsonist labor demand (MD) curve intersects the supply curve (SL) as shown in figure 3b.
Labor productivity is measured by dividing the total output by the number of laborers. An increase in labor productivity indicates that output per laborer has improved. There are several reasons that can contribute to increased productivity, such as motivated workers, ongoing training and skill upgrades for employees. Additionally, a better working environment can also play a role in fostering higher labor productivity.
Increase in productivity will lead to a higher Marginal Product of labour (MPL), and subsequently a rise in the MRPL for the firm. This is because the firm can now produce more output per additional worker, and the additional output generated contributes more revenue. Hence, the entire MRPL curve for the firms in both markets shifts outwards as shown in Figure 3(a) and (b).
Both firms will increase the quantity of labour hired from Q1 to Q2. However, in a perfectly competitive labor market, the firm is a wage taker, and the wage rate is determined by the market forces of supply and demand. This means that all firms in the market pay the same wage rate, which is equal to the market wage rate (W1). The wage rate is unaffected by an individual firm's hiring decisions and is determined by the overall labor market conditions.
Conversely, the outward shift in the MRP curve create upward pressure on wages in the monopsony. As the employer seeks to maximize its profits, it will now have an incentive to offer higher wages to attract and retain more workers. Figure 3b illustrates this new wage rate at W2. While an increase in MRP may lead to higher wages, the extent of the wage increase depends on the employer's monopsony power. If the employer has significant market power, it may still have the ability to suppress wages and retain a substantial portion of the productivity gains. Furthermore, the bargaining power of workers and the presence of labor unions can also play a role in determining the actual wage increase. Strong collective bargaining can lead to workers successfully negotiating for a larger share of the productivity gains.
While perfect competition ensures that workers receive the same market wage rate across all firms, it also implies that workers can easily move between firms since there are no barriers to entry or exit. As a result, firms must remain efficient and competitive to attract and retain workers.
In conclusion, an increase in labor productivity affects firms differently in monopsony and perfectly competitive labor markets. While increased productivity leads to higher wages in the monopsony, the wage rate remains constant in the perfectly competitive labor market. Understanding the dynamics of these two labor market structures is essential for policymakers and stakeholders to create an equitable and efficient labor market system.