How does a single buyer of labor set the wage and employment, and why are both lower than in a competitive market?
Topic 5.4 Monopsonistic Markets: explain why a monopsonist's marginal factor cost lies above the labor supply curve, find the monopsony wage and employment, and compare them with the competitive outcome.
A focused answer to AP Microeconomics Topic 5.4, covering monopsony as a single buyer of a factor, why marginal factor cost lies above the supply curve, how the monopsonist sets employment where marginal revenue product equals marginal factor cost and the wage off the supply curve, and the resulting lower wage and employment, with worked exam-style questions.
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What this topic is asking
Topic 5.4 is the factor-market parallel of monopoly: a monopsony, a market with a single buyer of a factor. The College Board wants you to explain why a monopsonist's marginal factor cost lies above the labor supply curve, find the monopsony wage and employment (employment where , wage off the supply curve), and compare them with the competitive outcome, where both are higher.
Why marginal factor cost exceeds the wage
This is the heart of the topic. In a competitive factor market each extra worker costs the constant market wage (marginal factor cost equals the wage). For a monopsonist, each extra worker costs the new wage plus the raise given to all the existing workers, so marginal factor cost is above the supply curve. The relationship mirrors monopoly in product markets, where marginal revenue lies below price for the same "applies to all units" reason.
Setting the monopsony wage and employment
The two-step method resembles the monopoly method. Step one: find employment where the and curves cross. Step two: drop down from that employment level to the supply curve to read the wage (never to the MFC or MRP curve). The result is a wage gap: workers are paid less than the value of their marginal product (), which is the exploitation associated with monopsony.
Comparison with the competitive outcome
In a competitive labor market, the wage and employment are set where labor demand () meets labor supply, and the wage equals the marginal revenue product. A monopsonist, by contrast, restricts hiring (where , to the left of the competitive point) and pays a lower wage (off the supply curve). So both employment and the wage are lower under monopsony than under competition.
A striking implication for policy: a minimum wage (or a union-negotiated wage) set above the monopsony wage but at or below the competitive wage can raise both the wage and employment, because it flattens the firm's effective marginal factor cost. This is the opposite of the minimum wage's employment-reducing effect in a competitive market, and a favorite exam contrast.
Try this
Q1. Explain why a monopsonist's marginal factor cost lies above the labor supply curve. [2 points]
- Cue. To hire one more worker it must raise the wage for all workers (the supply curve slopes up), so the extra cost of a worker exceeds the wage paid, putting marginal factor cost above supply.
Q2. State how the monopsonist reads off the wage once it has set employment. [1 point]
- Cue. It drops down from the employment level to the supply curve and reads the wage there (below the marginal revenue product).
Exam-style practice questions
Practice questions written in the style of College Board exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
AP 2018 (style)1 marksMultiple choice. Compared with a perfectly competitive labor market, a monopsonist hires (A) more workers and pays a higher wage. (B) fewer workers and pays a lower wage. (C) the same number of workers at a higher wage. (D) more workers at the competitive wage. (E) fewer workers at a higher wage.Show worked answer →
The answer is (B). A monopsonist (a single buyer of labor) faces an upward-sloping supply curve, so its marginal factor cost lies above the supply curve. It hires where marginal revenue product equals marginal factor cost, which is fewer workers than the competitive level, and pays the wage read off the supply curve, which is below the competitive wage.
(A), (C), (D), and (E) all misstate the lower-employment, lower-wage result.
AP 2021 (style)5 marksFree response. A monopsonist is the only employer in a town. (a) Explain why its marginal factor cost lies above the labor supply curve. (b) Draw a correctly labelled graph showing MRP, supply (S), and marginal factor cost (MFC). (c) Identify the monopsony employment level. (d) Identify the monopsony wage. (e) Compare the monopsony wage and employment with the competitive outcome.Show worked answer →
A five-point monopsony FRQ.
(a) (1 point): to hire one more worker the firm must raise the wage for all workers (the supply curve slopes up), so the extra cost (marginal factor cost) exceeds the wage paid, placing MFC above supply.
(b) (1 point): a downward-sloping MRP, an upward-sloping supply curve, and an MFC curve above and steeper than supply.
(c) (1 point): employment is where MRP = MFC.
(d) (1 point): the wage is read down from that employment level to the supply curve (below MRP and below MFC).
(e) (1 point): the monopsonist hires fewer workers and pays a lower wage than a competitive labor market, where the wage would equal MRP at the supply intersection.
Related dot points
- Topic 5.1 Introduction to Factor Markets: explain that factor demand is derived demand, define and calculate marginal revenue product, and state the hiring rule that marginal revenue product equals marginal factor (resource) cost.
A focused answer to AP Microeconomics Topic 5.1, covering derived demand, marginal product and marginal revenue product, marginal factor (resource) cost, and the profit-maximizing hiring rule that marginal revenue product equals marginal factor cost, with worked exam-style questions.
- Topic 5.2 Changes in Factor Demand and Factor Supply: identify the determinants that shift factor demand and factor supply, and predict the effect on the equilibrium factor price and quantity.
A focused answer to AP Microeconomics Topic 5.2, covering the determinants that shift factor (labor) demand and supply, including product demand, productivity, prices of other factors, and the number of workers, and how shifts change the equilibrium wage and employment, with worked exam-style questions.
- Topic 5.3 Profit-Maximizing Behavior in Perfectly Competitive Factor Markets: apply the marginal revenue product equals wage rule for a wage-taking firm, and use the least-cost and profit-maximizing input combination rules across multiple factors.
A focused answer to AP Microeconomics Topic 5.3, covering the hiring rule for a firm in a competitive factor market, the least-cost combination of inputs rule, the profit-maximizing input rule, and how a firm chooses between labor and capital, with worked exam-style questions.
- Topic 4.2 Monopoly: find the monopolist's profit-maximizing price and output using marginal revenue equals marginal cost, measure profit or loss, identify the deadweight loss, and explain natural monopoly and regulation.
A focused answer to AP Microeconomics Topic 4.2, covering how a monopolist chooses output where marginal revenue equals marginal cost and reads price off the demand curve, measures profit, creates deadweight loss, sustains long-run profit behind barriers, and how natural monopoly and price regulation work, with worked exam-style questions.
- Topic 6.4 The Effects of Government Intervention in Different Market Structures: analyze antitrust policy, the regulation of a natural monopoly through marginal-cost and average-cost pricing, and how intervention can reduce deadweight loss when a market failure exists.
A focused answer to AP Microeconomics Topic 6.4, covering antitrust policy against market power, the regulation of a natural monopoly through marginal-cost and average-cost (fair-return) pricing, and how well-targeted intervention can reduce deadweight loss when a market failure exists, with worked exam-style questions.
Sources & how we know this
- AP Microeconomics Course and Exam Description — College Board (2023)