5.4 Monopsony Markets

A monopsony is a labor market with one big employer (buyer) and many workers (sellers), which gives the firm power to set wages below what a competitive market would pay. The key idea is that marginal factor cost (MFC) is greater than the supply curve, so the firm hires where marginal revenue product (MRP) equals MFC and then pays the lower wage shown on the labor supply curve.

Monopsony Graph AP Micro

On a monopsony graph, the firm hires where MRP = MFC, then pays the wage from the labor supply curve at that quantity. That two-step process is the most important graph skill: MRP = MFC gives the quantity, not the wage.

The MFC curve sits above the labor supply curve because hiring one more worker requires raising the wage for the new worker and for workers already hired. Compared with a competitive labor market, a monopsony hires fewer workers and pays a lower wage.

more resources to help you study

practice multiple choiceFRQ practice & scoringcheatsheetsscore calculatorAMSCO guided noteskey terms

Why This Matters for the AP Microeconomics Exam

Factor markets are one of the trickier areas in AP Microeconomics, and monopsony is the part students miss most often. If you can read and draw a monopsony graph, you can handle questions about hiring quantity, wage setting, and how monopsony compares to a competitive labor market. This topic also shows up in problems where you calculate the profit-maximizing quantity of labor and explain why a minimum wage can actually raise employment in a monopsony, which is a result that surprises people.

You should be ready to:

• Define the characteristics of a monopsonistic labor market.
• Explain a firm's hiring decision when other inputs are fixed.
• Calculate the quantity of labor and the wage using a graph or table.

Key Takeaways

• A monopsony has one buyer of labor and many sellers, so the firm has wage-setting power.
• The labor supply curve slopes upward, and because the firm cannot pay different workers different wages, MFC lies above the supply curve.
• The firm hires labor as long as MRP is greater than MFC, and stops where MRP = MFC.
• The wage is set on the supply curve at that quantity, so the monopsony wage is below MRP and below the competitive wage.
• Compared to a competitive labor market, a monopsony hires fewer workers and pays a lower wage.
• A minimum wage set above the monopsony wage can increase employment, unlike in a competitive market.

What a Monopsony Is

A monopsony is an imperfectly competitive factor market with a single buyer of resources and many sellers. In a labor market, that means one firm hires most or all of the workers. A classic example used to picture this is a small town where one company, like a coal mine or a single lumber mill, is the only employer. Workers can sell their labor, but the firm is the only buyer, so it has market power over the wage.

This is a contrast to a perfectly competitive labor market, where the wage is set by the overall market and each firm just takes that wage as given.

Characteristics of a Monopsony

• One dominant buyer of labor. A single firm hires in the labor market and is large enough to influence the wage.
• Imperfectly competitive. It does not fit the assumptions of a perfectly competitive labor market.
• Wage setter. Because the firm is the main source of labor demand, it has control over the wage and pays the lowest wage workers are willing to accept at its chosen quantity.
• MFC is above the supply curve. When the firm hires one more worker, it must offer a higher wage to attract that worker. Since it cannot pay earlier workers less, it also raises the wage for everyone already hired. That extra cost makes marginal factor cost greater than the supply (willingness to sell) curve.
• Hires where MRP = MFC. This is the profit-maximizing rule for factor markets.
• Pays a wage below MRP. The firm uses its market power to pay less than the value the last worker adds.

The MFC above supply logic mirrors why a monopoly's marginal revenue lies below its demand curve. In both cases, one decision affects the price paid (or received) for every unit, not just the last one.

Graphing a Monopsony

Start with these curves:

• Demand = MRP. A firm demands labor based on the revenue each worker brings in, so the labor demand curve is the marginal revenue product curve. It slopes downward because of diminishing marginal returns.
• Supply (S). The upward-sloping labor supply curve shows the wage workers are willing to accept at each quantity.
• MFC. Marginal factor cost lies above the supply curve because hiring one more worker raises the wage paid to all workers.

To read the graph:

1. Find the quantity of labor where MRP = MFC. Drop straight down to the horizontal axis to get the profit-maximizing quantity.
2. To find the wage, go from that quantity up to the supply curve, then over to the vertical axis. The firm pays the lowest wage workers will accept at that quantity, which the supply curve defines.

This produces the monopsony result: fewer workers hired and a lower wage than a competitive labor market, where employment would be found where MRP = S.

Worked Example: AP Micro 2011B, Problem 3

Woodland is a small town where everyone works for TreeMart, the local lumber company. TreeMart is a monopsonist in the labor market and a perfect competitor in the lumber market. In the short run, labor is the only variable input.

a) Identify the profit-maximizing quantity of labor. TreeMart hires where MRP = MFC. In this problem that is at QL = 100.

b) Identify the wage rate TreeMart pays at that quantity. At QL = 100, go down to the supply curve to find the lowest wage workers will accept: w = 10.

c) Identify the quantity of labor hired in each scenario:

• i) Competitive labor market. In a competitive market the firm hires where S = MRP, giving a quantity of 200.
• ii) Minimum wage of $12.50. A minimum wage acts as a price floor. Up to the point where supply rises above the floor, the wage (and the firm's MFC) is fixed at $12.50, so the supply the firm faces is flat at that wage. The firm hires where MRP equals $12.50, which gives Q = 150.

Part c shows the key policy result: setting a minimum wage above the monopsony wage but below MRP can both raise the wage and increase the number of workers hired. That is the opposite of what a minimum wage does in a competitive market, where it tends to reduce employment.

How to Use This on the AP Microeconomics Exam

Free Response

• Draw a clearly labeled graph with MRP (demand), supply, and MFC, with MFC above supply.
• Always find quantity first by setting MRP = MFC, then drop down to supply to find the wage. Mixing up these steps is the most common error.
• When asked to compare to a competitive market, label both the competitive point (MRP = S) and the monopsony point so the difference in wage and employment is visible.

Problem Solving

• From a table, compute MFC as the change in total labor cost when you add one worker, not just that worker's wage. MFC will rise faster than the wage.
• Hire each additional worker only while MRP is greater than MFC, and stop at the last worker where MRP is still at least MFC.

Common Trap

• With a minimum wage in a monopsony, the supply curve the firm faces becomes horizontal at the wage floor up to where the original supply curve catches up. That flat segment is why a well-set minimum wage can raise employment. Do not assume a minimum wage always lowers employment.

Common Misconceptions

• MFC equals the wage. In a monopsony, MFC is greater than the wage because hiring one more worker raises the wage for all workers. The wage comes from the supply curve, not the MFC curve.
• The wage is set where MRP = MFC. That intersection gives the quantity, not the wage. You read the wage off the supply curve at that quantity.
• A monopsony pays workers their MRP. It does not. The monopsony wage sits below MRP, which is the source of the lower pay compared with a competitive market.
• A minimum wage always cuts jobs. In a competitive market it can, but in a monopsony a minimum wage set above the monopsony wage and at or below MRP can increase employment.
• A monopsony means one seller. That is a monopoly. A monopsony is one buyer with many sellers.

Related AP Microeconomics Guides

• 5.1 Introduction to Factor Markets
• 5.3 Perfectly Competitive Labor Markets
• 5.2 Changes in Factor Demand and Factor Supply
• Unit 5 Overview: Factor Markets