The determination of relative wage rates and levels of employment in imperfectly competitive labour markets - Economics (9640) - Oxford AQA A-Level

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Welcome to the World of Imperfect Labour Markets!

Hello Economists! In the previous chapter, we looked at the simple, ideal world of Perfect Competition. But let's be honest, very few jobs in the real world operate like that. This chapter dives into the messy, fascinating reality: Imperfect Labour Markets.

Understanding this is crucial because it explains why some workers earn very high wages while others earn very little, even if they have similar skills. We will focus on two major sources of imperfection: employers with market power (Monopsony) and workers with market power (Trade Unions). Get ready to draw some essential diagrams!

Quick Review: Why Labour Markets Are "Imperfect"

A perfectly competitive labour market assumes many buyers (employers) and many sellers (workers), perfect information, and perfect factor mobility. In reality, these assumptions often break down, leading to imperfect markets.

Imperfect Information: Workers don't always know where the best-paying jobs are, and firms don't always know the exact productivity of every potential employee.
Immobility of Factors: Workers cannot instantly move jobs or locations (geographical and occupational immobility).
Market Power: Either the employer or the employee (through a union) has the power to influence the wage rate. This is our main focus.

1. Monopsony Power: When the Employer is King

The most common form of imperfection that drives down wages is Monopsony Power.

What is a Monopsony?

A Monopsony occurs when there is a single dominant buyer of labour in a specific market.

Example: Think of a remote town where the only major employer is a large factory or a local hospital. If you want a job in that town, you have only one main place to apply. This gives the employer immense power.

Why Monopsony Leads to Lower Wages and Employment

In a monopsony, the firm faces the entire upward-sloping market supply curve for labour. If they want to hire more workers, they must offer a higher wage to attract them.

This key feature creates a crucial relationship between two curves:

Average Cost of Labour (ACL): This is simply the Supply Curve of Labour (S). It shows the wage the firm must pay to attract a certain number of workers.
Marginal Cost of Labour (MCL): This is the *extra* cost of hiring one more worker. Since the firm must raise the wage for *all* existing workers to attract the new one, the MCL curve lies above the ACL curve.

Don't worry if this seems tricky! Think of it like this:
If a firm currently hires 10 workers at \$10 per hour (Total Cost = \$100), and to hire the 11th worker, they must raise the wage to \$11 for all 11 workers (New Total Cost = \$121). The MCL is \$21 (\$121 - \$100), which is much higher than the \$11 wage (ACL).

The Monopsony Equilibrium (Diagrammatic Analysis)

The monopsonist follows the standard profit-maximising rule, but in the factor market: they hire up to the point where the Marginal Revenue Product (MRP) equals the Marginal Cost of Labour (MCL).

Step-by-step determination:

Employment Level ($L_M$): The firm chooses the level of employment where the cost of the last worker equals the revenue generated by that worker:
$MCL = MRP$
Wage Rate ($W_M$): Once the employment level ($L_M$) is chosen, the monopsonist pays the lowest wage required to attract that number of workers. They find this wage by reading down from $L_M$ to the ACL (Supply) curve.
Comparison to Perfect Competition: If this market were perfectly competitive, equilibrium would be where Supply = Demand, or
$ACL = MRP$ The competitive wage and employment would be higher ($W_C$ and $L_C$).

Key Takeaway: A monopsonist restricts employment ($L_M < L_C$) and pays a wage lower than the competitive wage and lower than the value of the worker's output ($W_M < W_C$ and $W_M < MRP$). This is often seen as exploitation.

Did you know? Many nursing and teaching markets exhibit monopsonistic tendencies, as local governments or large trusts are often the dominant buyers of these specialized skills.

★ Quick Review: Monopsony

Power Source: Single buyer of labour.
Rule: MCL > ACL (Supply).
Outcome: Lower wages and lower employment compared to perfect competition.

2. Trade Unions and Collective Bargaining

Trade unions exist to act as a counterbalance to the power of employers. They introduce imperfections on the supply side of the labour market.

What is a Trade Union?

A Trade Union (or Labour Union) is a collective organisation of workers that aims to improve wages and working conditions through collective bargaining with the employer.

Unions effectively transform many individual sellers (workers) into a single, collective seller (the union), giving them market power.

Factors Affecting Trade Union Influence

The union's ability to influence wages and employment depends on its bargaining strength, which is affected by several factors:

Density and Membership: The higher the percentage of workers who are members, the stronger the union's threat of industrial action (like strikes).
Elasticity of Demand for Labour: If demand for the firm's labour is inelastic (workers are hard to substitute, like highly skilled engineers), the firm is less likely to cut jobs in response to a wage rise.
Profitability of the Firm: A highly profitable firm is more able to afford wage increases and less willing to endure a costly strike.
Legislation: Laws regarding strikes, picketing, and workers' rights can greatly affect union power.

Trade Unions in Competitive Labour Markets

If a union enters a previously perfectly competitive market, it effectively sets a minimum wage ($W_U$) above the market equilibrium wage ($W_C$).

Impact:

Wages Rise: Employees in the union achieve a higher wage ($W_U$).
Employment Falls: Because the firm is a wage taker and the wage is now higher, the quantity of labour demanded falls, leading to job losses and possibly excess supply of labour (unemployment).

3. Trade Unions vs. Monopsony: The Bilateral Monopoly

This is the most complex and interesting scenario, where both the buyer (employer/monopsonist) and the seller (union) possess market power. This is called a Bilateral Monopoly.

In this scenario, the union acts to counteract the monopsonist's power.

How a Union Changes the Monopsonist's Curves

If the union successfully negotiates a wage floor ($W_N$) above the monopsony wage ($W_M$):

The firm can now hire any number of workers up to the supply curve at that negotiated rate $W_N$.

The New ACL/Supply Curve: Becomes horizontal at $W_N$ until it hits the original market supply curve.
The New MCL Curve: For all workers hired at the negotiated wage, the cost of hiring one extra worker is just $W_N$. Therefore, the new MCL is also horizontal and equal to $W_N$, up to the point where the new supply curve meets the old one.

The Impact on Wages and Employment

The union's intervention can have a surprising result:

If the union sets the negotiated wage ($W_N$) optimally (specifically, close to the competitive wage $W_C$), the monopsonist will increase hiring because their marginal cost of labour has effectively fallen or been stabilised.

A union can raise wages AND employment simultaneously in a monopsony market.

The Indeterminate Outcome:
In a bilateral monopoly, the final wage rate and employment level are indeterminate. This means they cannot be precisely predicted by economic theory alone. Why?

It depends entirely on the relative bargaining strengths of the union and the monopsonist.

If the union is very strong, the wage might be pushed close to the MRP level (high wage, low employment relative to the competitive level).
If the employer is very strong, the wage might stay close to the original monopsony wage $W_M$.

Analogy: It's like a tug-of-war. We know the outcome depends on who is stronger (bargaining power), but we can't tell exactly where the rope will end up (the final wage).

4. The Determination of Relative Wage Rates

Relative wage rates refer to the wage paid in one occupation or market compared to another (e.g., the wage of a unionized factory worker compared to a non-unionized retail worker). Imperfect markets are the primary reason these differences exist, even for workers of similar skill levels.

Sources of Relative Wage Differences due to Imperfection:

Monopsony vs. Competitive Sector: Workers in monopsonistic regions or industries (e.g., specific mining towns) will earn relatively lower wages than those in highly competitive sectors (e.g., metropolitan service industries), holding productivity equal.
Unionised vs. Non-Unionised Sectors: A successful trade union creates a "wage premium" for its members. The relative wage of union members will be significantly higher than non-union members in comparable jobs.
Imperfect Information: Workers who lack information about better job opportunities may remain in low-paying jobs, artificially suppressing wages in their market relative to better-informed markets.
Discrimination: As discussed in the subsequent section (3.3.4.5), non-economic factors like gender, ethnicity, or age can result in lower relative wages and different levels/types of employment for certain groups, despite equal marginal revenue products.

Key Takeaway: Imperfect Markets are Real

In the real world, wages are not simply determined by Marginal Revenue Product alone. Imperfections—especially monopsony power and trade union power—distort the outcomes, leading to lower employment and wage levels than the theoretical efficient maximum. The outcome in a bilateral monopoly depends on which side can negotiate the hardest.