A2 Economics 9708: Monopsony Employer, MCL and Wage Determination

Northfield Logistics is the only significant employer of warehouse packers in the small town of Northfield, making it a monopsony employer of this type of labour. To attract more packers, it must raise the wage rate paid to all its packers, not just the newest recruit. The table below shows the wage rate (per hour) Northfield Logistics must pay to attract each level of employment, together with the marginal revenue product (MRP) of labour, both in dollars per hour.

Packers employed	Wage rate paid ($/hour)	Marginal revenue product, MRP ($/hour)
1	10	34
2	12	30
3	14	26
4	16	22
5	18	18
6	20	14

(a) Calculate the total cost of labour and the marginal cost of labour (MCL) when Northfield Logistics employs 4 packers and when it employs 5 packers. [3]

(b) Using your answer to (a) and the pattern this reveals across the table, determine the number of packers Northfield Logistics will employ to maximise profit, and the wage rate it will pay them. Explain your reasoning. [4]

(c) Explain why the wage Northfield Logistics pays is less than the marginal revenue product of the last packer it employs. [2]

(d) State the number of packers that would be employed, and the wage that would be paid, if this labour market were instead perfectly competitive. Briefly explain why monopsony power results in both lower employment and a lower wage than in a competitive labour market. [3]

Part (a): Total cost of labour and marginal cost of labour at 4 and 5 packers

Total cost of labour (TCL) is the wage rate multiplied by the number of packers employed, since Northfield Logistics must pay the same wage to every packer it hires:

$TCL(4) = 16\times4 = 64$ $TCL(5) = 18\times5 = 90$

To find the marginal cost of labour (MCL), the extra total cost of hiring one more packer, we also need $TCL(3) = 14\times3 = 42$ . Then:

$MCL(4) = TCL(4)-TCL(3) = 64-42 = 22$ $MCL(5) = TCL(5)-TCL(4) = 90-64 = 26$

Note that MCL exceeds the wage rate paid in both cases ($22 $>$ $16, and $26 $>$ $18): hiring one more packer costs more than that packer’s own wage, because the higher wage must also be paid to every packer already employed.

Part (b): Profit-maximising employment and wage

Extending the same method to every row of the table gives the full marginal cost of labour schedule:

Packers	Wage rate	Total cost of labour	MCL	MRP
1	10	10	10	34
2	12	24	14	30
3	14	42	18	26
4	16	64	22	22
5	18	90	26	18
6	20	120	30	14

A profit-maximising employer hires an extra worker whenever that worker’s MRP is at least as large as the MCL of hiring them, since this adds more (or as much) to revenue as it adds to cost:

Packers 1 to 4: MRP (34, 30, 26, 22) is greater than or equal to MCL (10, 14, 18, 22) at every step, so each is worth hiring.
Packer 5: MRP of 18 is less than MCL of 26, so hiring a 5th packer would reduce profit.

Profit is therefore maximised at 4 packers, where $MCL = MRP =$ $22. Northfield Logistics does not need to pay $22 to attract exactly 4 packers, however. From the wage-rate column, only $16 per hour is needed to attract 4 packers, and that is the wage it actually pays each of them.

Part (c): Why the wage paid is below MRP

Northfield Logistics is the only significant buyer of this type of labour, so it faces the whole market supply curve of packers (the wage-rate column) rather than being able to hire as many workers as it likes at a fixed wage. Because raising employment means raising the wage of every packer already on the payroll, not just the additional one, the marginal cost of hiring an extra packer (MCL) rises faster than the wage rate itself and lies above it at every level of employment beyond the first. Profit-maximisation requires $MCL=MRP$ , which happens at 4 packers, but the wage Northfield Logistics must actually pay to attract those 4 packers (read from the wage-rate schedule, not the MCL schedule) is only $16, well below the $22 marginal revenue product of the 4th (last) packer employed. The gap between the $22 MRP and the $16 wage is effectively retained by the firm rather than passed on to workers, which would not happen in a competitive labour market.

Part (d): Comparison with a perfectly competitive labour market

If this labour market were instead perfectly competitive, Northfield Logistics (and other employers) would be wage-takers, and the wage-rate column would represent the ordinary market supply curve of labour. The competitive equilibrium is then found where labour demand (MRP) equals labour supply (the wage-rate row), rather than where MRP equals MCL:

At 5 packers, $MRP=18$ and the wage rate is also $18$ , they are equal.

So a competitive labour market would result in 5 packers employed at a wage of $18 per hour (one more packer, and a $2 per hour higher wage, than under monopsony (4 packers at $16). Monopsony power lets Northfield Logistics restrict employment below this competitive level precisely because, as sole buyer, it recognises that hiring one more packer would raise the wage bill of all its existing packers as well; by deliberately stopping short of the competitive employment level, it keeps the wage) and therefore its total wage bill. Lower than a competitive market would produce.

Final answers

(a) $TCL(4)=$ $64, $TCL(5)=$ $90; $MCL(4)=$ $22, $MCL(5)=$ $26
(b) Profit-maximising employment $=$ 4 packers (where $MCL = MRP =$ $22); wage paid $=$ $16 per hour
(c) The wage ($16) is below MRP ($22) because MCL exceeds the wage rate for a monopsonist, since hiring one more worker raises the pay of all existing workers too
(d) Competitive outcome: 5 packers at $18 per hour, monopsony results in lower employment and a lower wage than a competitive market