18 [33]
Unions, Monopsony, and
Imperfect Information
Chapter Summary
This chapter extends the discussion of the labor market beyond the world of the competitive labor market
where each side takes the market wage as given. Here are the main points of the chapter:
 A union faces a trade-off between wages and total employment. An increase in the wage causes
an output effect and an input-substitution effect that combine to decrease the quantity of labor
demanded.
 The gap between the union wage and the nonunion wage will be relatively large when the price
elasticity of demand for a product is relatively low. Demand is relatively inelastic in less
competitive product markets.
 A firm facing a positively sloped labor supply curve must pay a higher wage to hire more
workers, and the marginal labor cost exceeds the wage.
 The equilibrium employment in a monopsony is less than the equilibrium employment in a
perfectly competitive market.
 In a labor market with asymmetric information about worker productivity, an increase in the
wage may increase the average productivity of hired workers and increase profit.
Applying the Concepts
After reading this chapter, you should be able to answer these four key questions:
1. Is there a trade-off between union wages and the number of union jobs?
2. How does competition in the product market affect union wages?
3. Do firms face a positively sloped labor-supply curve?
4. When is it profitable to pay an above-market wage?
18.1 [33.1] Labor Unions
A labor union is a group of workers organized to increase job security, improve working conditions, and
increase wages and fringe benefits. One primary type of labor union is a craft union, a labor organization
that includes workers from a particular occupation, for example, plumbers, bakers, or electricians. The
other primary type of labor union is an industrial union, a labor organization that includes all types of
workers from a single industry, for example, steelworkers or autoworkers. The primary focus of unions is
collective bargaining, negotiations between a union and a firm over wages, fringe benefits, job security,
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and working conditions. In collective bargaining, the union represents all covered workers in negotiations
with the firm.
There are three key pieces of legislation related to unions:
 The National Labor Relations Act (Wagner Act) passed in 1935. This gave workers the right to
join a union and required firms to negotiate with unions representing their workers. The National
Labor Relations Board was created to oversee union organizing and activity.
 The Labor Management Relations Act (Taft-Hartley Act) passed in 1947. This law gave states the
right to pass right-to-work laws. A right-to-work law is a law that prohibits union shops, where
union membership is required as a condition of employment. The Act also allowed the
government to stop strikes that “imperiled the national health or safety.”
 The Labor Management Reporting and Disclosure Act (Landrum-Griffin Act) passed in 1959.
This Act guaranteed free elections within unions, forced more financial disclosure from unions,
and made theft of union funds a federal offense.
Estimates suggest that in the United States, union workers earn 10 to 20 percent more than similar nonunion workers. Both the output effect and the input-substitution effect from the last chapter suggest that in
exchange for higher wages, unions reduce employment in covered sectors.
The output effect, the decrease in output due to fewer units being sold, will be higher when:
 A large fraction of costs come from labor. The larger the fraction of labor costs, the greater the
price increase for the final good.
 Demand is elastic. More elastic demand will have a greater quantity decrease in response to any
price increase.
To prevent job loss from higher wages, unions typically negotiate work rules that increase the amount of
labor needed to do a job. This is commonly called featherbedding, imposing work rules that increase the
amount of labor required to produce a given quantity of output. By forcing labor costs higher,
featherbedding may further decrease the output of the final good which is sold in the market.
On the positive side, unions may:
 Increase worker productivity by increasing communication between workers and management.
 Reduce turnover among employees.
Let’s review two Applications that answer key questions we posed at the start of the chapter:
1. Is there a trade-off between union wages and the number of union jobs?
APPLICATION 1: TRUCKERS TRADE OFF WAGES AND JOBS
This Application illustrates the trade-off between wages and jobs for unionized truck drivers in
response to the entry of nonunion trucking. Point a in Figure 18.2 [33.2] shows the initial wage,
trucker point. As nonunion truckers became more common, the demand for union truckers fell. If
wages remained constant at $20 per hour, union employment would have fallen from 526,000
truckers to 263,000 illustrated at point b. By allowing wages to fall to $14, union employment
was able to move to 439,000 truckers, illustrated by point c.
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2. How does competition in the product market affect union wages?
APPLICATION 2: COMPETITION REDUCES TRUCKER WAGES
In the full-truckload sector of the trucking market, entry is relatively easy as anyone with a truck
and a license can enter the industry. In the less-than-truckload sector, it is more difficult to enter
as more complex organization and support systems must be in place. Because of the ease of entry
into the full-truckload sector, unionized truckers earn a smaller wage premium in this sector than
in the less-than-truckload sector.
18.2 [33.2] Monopsony Power
A monopsony is a market in which there is a single buyer of an input.
 Study Tip
A monopsony in the buyers’ market is analogous to a monopoly in the seller market.
In a monopsony market, the buyer of the input faces the market supply curve for the input. As a result, the
marginal labor cost of hiring another input is greater than the wage paid to the last worker. The marginal
labor cost is the increase in a firm’s total labor cost resulting from one more unit of labor. The reason is
that the firm must increase the wages of all its workers in order to offer a higher wage to a new worker.
(This is analogous to the price exceeding marginal revenue in a monopoly market.)
 Key Equation
marginal labor cost = wage paid to new worker + (change in wage x original quantity of
labor)
A monopsonist will follow the marginal principle when choosing how many workers to hire and will hire
to the point where the marginal-revenue product equals the marginal labor cost.
The Marginal Principle
Increase the level of an activity as long as its marginal benefit exceeds its marginal cost. Choose the level
at which the marginal benefit equals the marginal cost.
Figure 18.4 [33.4] of the text shows the monopsonist’s decision. At point a the marginal-revenue product
curve, the demand curve for labor, and the marginal labor cost curve intersect. At this point, 40 workers
will be hired. The monopsonist will pay the wage required off the supply curve to hire 40 workers, in this
case $4, illustrated at point b. The competitive labor market outcome will occur at point c, with a higher
wage and greater employment than the monopsony result.
Table 18.1 [33.1] in your text illustrates the similarities between monopsony input markets and monopoly
output markets.
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When a market contains a monopoly seller of labor, such as a union, and a monopsony buyer of labor
wage and employment levels will be determined by bargaining between the two parties. The actual wage
will fall between the below-market wage of a monopsony market and the above-market wage of the union
market.
A minimum wage can reduce monopsony power by allowing the firm to buy additional units of labor at a
constant cost, at least up to the minimum wage. Figure 18.5 [33.5] in your text illustrates this. In this
graph, until we reach point d, the marginal labor cost facing the firm is constant at the minimum wage of
$7. At this wage the firm will hire 50 workers, found at point e in the Figure.
While true monopsony markets are rare in the real world, there are markets where hiring additional
workers means increasing the wages of all workers in the market. In these cases, wages and employment
will be lower than in a competitive labor market.
 Remember
If a firm must increase wages to all workers to attract additional labor, the marginal labor
cost curve will lie above the supply curve for labor. In this case, wages and employment
will be lower than in a competitive labor market.
Let’s review an Application that answers one of the key questions we posed at the start of the chapter:
3. Do firms face a positively sloped labor-supply curve?
APPLICATION 3: PUBS AND THE LABOR-SUPPLY CURVE
This Application suggests that the labor-supply curve is in fact upward sloping and it uses clever
intuition to do so. If the labor-supply curve was flat, then when workers left old jobs for new jobs,
their wages would be the same. If this is the case, there is no reason to celebrate. The fact that
workers celebrate new jobs and lament the loss of old jobs (if they are fired or laid off) suggests
that the labor-supply curve is upward sloping.
 Study Tip
Application 3 is a nice example of finding real-world situations to test economic theory. As
you interact in the economy, try looking for similar tests of the theory that you have learned
in this class.
18.3 [33.3] Imperfect Information and Efficiency Wages
The labor market is a mixed market, some workers are very productive, and other workers are not. It is
difficult to know in advance whether you are hiring a high-productivity worker or a low-productivity worker.
 Think about sitting in a job interview. The interviewer asks you what you would consider your biggest
weakness as an employee. Are you going to answer that you are a perfectionist who sometimes obsesses
until a particular job is done, or are you going to answer that you are frequently lazy and unmotivated?
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Every person interviewing for a job will say that they are a perfectionist. You know from co-workers you
have had that this isn’t the case.
In Table 18.2 [33.2], we see that we must pay at least $25 to hire a low-productivity worker and $50 to hire a
high-productivity worker. Paying wages above $40 means we lose money on each low-productivity worker.
Table 18.3 [33.3] shows equilibrium wages with asymmetric information. Notice that at any wage below
$50, we hire only low-productivity workers. At any wage above $50 we hire a mix of high- and lowproductivity workers. The table illustrates that the wage will continue to rise until it reaches $60 at which
point the expected marginal revenue product per worker will equal the marginal cost per worker.
Paying efficiency wages is the practice of paying a higher wage to increase the average productivity of
the workforce. There are two other benefits from efficiency wages, both due to the fact that an employee
will have difficulty finding another job paying above-market wages:
 Efficiency wages reduce shirking.
 Efficiency wages reduce turnover.
Let’s review an Application that answers one of the key questions we posed at the start of the chapter:
4. When is it profitable to pay an above-market wage?
APPLICATION 4:
WHY DO LAW FIRMS PAY MORE FOR JANITORS AND SECRETARIES
Why would a janitor or secretary earn more in a law firm than if they worked elsewhere? This
Application suggests that the reason is the cost of supervision. Because lawyers earn more, the
cost of taking time to supervise janitors and secretaries is higher for a lawyer than it would be for
someone in a lower paying occupation. By paying efficiency wages lawyers can spend less time
supervision janitors and secretaries and more time working on billable cases.
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Activity
Consider the labor market described in the following table. The wage rate is w, labor demand and labor
supply are given as Ld and LS and the marginal labor cost is MLC.
w
0
1
2
3
4
5
6
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Ld = MRP
90
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LS MLC
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a. Fill in the marginal labor cost column.
b. In a competitive labor market, the market wage will be _______________ and __________ workers
will be employed.
c. Suppose a monopoly enforces a wage of $16 in the market. In this case, the number of workers
employed will be ______________.
d. If the labor market has only one buyer, there will be ___________ workers employed and the wage
rate will be ___________.
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Answers
a.
w
0
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5
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8
9
10
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13
14
15
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17
18
Ld = MRP
90
85
80
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70
65
60
55
50
45
40
35
30
25
20
15
10
5
0
LS
0
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MLC
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33
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b. In a competitive labor market, the wage will be $15 and 15 workers will be employed.
c. If a union raises the wage to $16, employment will fall to 10 workers.
d. In a monopsony market, firms will hire 13 workers at a wage of $13.
Key Terms
Collective bargaining: Negotiations between a union and a firm over wages, fringe benefits, job security,
and working conditions.
Craft union: A labor organization that includes workers from a particular occupation, for example,
plumbers, bakers, or electricians.
Featherbedding: Work rules that increase the amount of labor required to produce a given quantity of output.
Industrial union: A labor organization that includes all types of workers from a single industry, for
example, steelworkers or autoworkers.
Labor union: A group of workers organized to increase job security, improve working conditions, and
increase wages and benefits.
Marginal labor cost: The increase in a firm’s total labor cost resulting from one more unit of labor.
Monopsony: A market in which there is a single buyer of an input.
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Paying efficiency wages: The practice of paying a higher wage to increase the average productivity of the
workforce.
Right-to-work laws: Laws that prohibit union shops, where union membership is required as a condition
of employment.
Practice Quiz
(Answers are provided at the end of the Practice Quiz.)
1. A perfectly competitive firm in the labor market will:
a. have a marginal cost of labor that is equal to the market wage rate.
b. face an upward sloping market supply curve for labor.
c. face a downward sloping market supply curve for labor.
d. set the marginal cost of labor equal to the marginal product of labor.
2. Select the best answer. A craft union is:
a. an organized group of workers that can influence wages.
b. an organized group of workers from a particular occupation like plumbers, bakers, or electricians.
c. a union that includes workers from a single industry like steelworkers or autoworkers.
d. a union that negotiates solely to obtain better working conditions.
3. Which of the following groups of workers had the highest unionization rates in the United States in
2007?
a. All wage and salary workers as a whole.
b. Public-sector workers.
c. Private-sector workers.
d. None of the above. All of the groups above had about the same unionization rates.
4. Which of the following pieces of legislation guaranteed workers the right to join unions and required
each firm to bargain with a union formed by a majority of its workers?
a. The Taft-Harley Act.
b. The Wagner Act.
c. The Landrum-Griffin Act.
d. The Sherman Act.
5. Which of the following institutions was established to enforce the provisions of the Wagner Act?
a. The National Labor Relations Board.
b. The Toastmasters.
c. The Air Traffic Controllers Association of America.
d. The Jimmy Hoffa Workers of America.
6. What is the purpose of right-to-work laws?
a. To ensure that unionized workers are given the right to work.
b. To outlaw union membership as a precondition of employment.
c. To ensure that workers can be employed without having to join a union.
d. To prevent business firms from firing unionized workers.
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7. Which of the following acts was a response to allegations of corruption and misconduct by union
officials?
a. The Wagner Act.
b. The Sherman Act.
c. The Landrum-Griffin Act.
d. The Taft-Harley Act.
8. An increase in the wage decreases the quantity of labor demanded because of the output effect and the
input-substitution effect. Which one is the input-substitution effect?
a. As the wage increases, a worker will substitute income for leisure time.
b. An increase in the wage increases a worker’s real income in the sense that she can afford more of
all goods, including leisure time.
c. An increase in the wage increases the cost of production, and a firm will pass on the higher cost
to consumers by increasing its product price.
d. An increase in the wage increases the cost of labor relative to the cost of capital, and the firm will
substitute capital for labor,
9. This question tests your understanding of Application 1 in this chapter: Truckers trade off wages and
jobs: Is there a trade-off between union wages and the number of union jobs?
Refer to the figure below. The figure shows the possible responses of union truckers to the entry of
nonunion firms. In 1978, the union wage was $20 per hour and union employment was 526,000
truckers (point a). Which of the following best describes how union truckers reacted to the entry of
nonunion firms?
a.
b.
c.
d.
The move from a to b.
The move from a to c.
The move from a to b, and then to c.
The move from a to c, and then to b.
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10. Fill in the blanks. Higher wages lead to a higher output price, less quantity demanded, and therefore
less workers hired. This effect is particularly strong when the product’s demand is _________ and
labor costs are a _________ fraction of the costs.
a. inelastic; large
b. elastic; large
c. inelastic; small
d. elastic; small
11. Featherbedding is the practice of:
a. guaranteeing a job for every worker who is a union member.
b. giving preference to union members versus nonunion members for new jobs that become
available.
c. imposing work rules that increase the amount of labor required to produce a given quantity of
output.
d. giving workers all the tools that are necessary to produce a given quantity of output.
12. Which of the following statements about the effects of unions on worker productivity and turnover is
correct?
a. Unions may increase productivity and lower turnover.
b. Unions may increase productivity, but also increase turnover.
c. Unions may lower productivity and increase turnover.
d. Unions have no impact on productivity and turnover.
13. To determine how many workers to hire, which key principle of economics should the profitmaximizing monopsonist use?
a. The principle of opportunity cost.
b. The marginal principle.
c. The principle of diminishing returns.
d. The principle of voluntary exchange.
14. Fill in the blanks: To hire more workers, the monopsonist must pay a ________ wage, so the
marginal labor cost __________ the wage.
a. higher...is greater than
b. higher...is less than
c. lower...is greater than
d. lower...is less than
15. Just as a monopolist uses its market power to increase the price of output, a monopsonist uses its
market power to:
a. increase other input prices, but not the wage.
b. decrease the wage.
c. decrease the price of the output.
d. increase the wage.
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16. Refer to the figure below. What is the marginal labor cost of the 8th worker?
a.
b.
c.
d.
$48.
$56.
$52.
$38.
17. Refer to the figure below. If the firm decides to hire 40 workers, what wage will it pay to each
worker?
a.
b.
c.
d.
$4.
$6.
$8.
There is insufficient information to answer the question.
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18. Refer to the figure below. Which of the supply curves does the monopsonist face in the presence of a
minimum wage?
a.
b.
c.
d.
The solid line portion of Curve 2, but not the dashed segment.
Part of Curve 1 and part of the horizontal supply curve.
The solid line portion of Curve 2 and the entire horizontal line at $7.
The entire upward sloping Curve 2, including the dashed segment.
19. This question tests your understanding of Application 3 in this chapter: Pubs and the labor-supply
curve: Do firms face a positively sloped labor-supply curve?
In which of the following situation is the labor supply curve is positively sloped?
a. When the labor market is perfectly competitive.
b. When the product market is perfectly competitive.
c. When the labor market is less competitive.
d. When workers earn a wage equal to the opportunity cost of their time.
20. What happens when there is asymmetric information in the labor market?
a. The firm hires only high-skill workers.
b. The firm must increase its wage in order to attract more high-skill workers.
c. The firm does not have to pay higher wages in order to attract higher-skilled workers.
d. The firm hires only low-skill workers.
21. Describe the problem of asymmetric information in the labor market.
22. What is an efficiency wage, and why do firms pay efficiency wages?
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Answers to the Practice Quiz
1. a. One of the assumptions of perfect competition in the labor market is that a firm can hire an
unlimited number of workers at the prevailing market wage, in other words, faces a horizontal supply
curve of labor. This means that the marginal cost of labor is equal to the prevailing market wage.
2. b. A craft union includes workers from a particular occupation like plumbers, bakers, or electricians,
while an industrial union includes all types of workers from a single industry like steelworkers or
autoworkers.
3. b. Public-sector workers have a higher unionization rate than private sector workers or all workers as
a whole. had a unionization rate of 37.5% in 2007.
4. b. The Wagner Act of 1935 guaranteed workers the right to join unions.
5. a. The National Labor Relations Board (NRLB) was established to enforce the provisions of the
Wagner Act.
6. c. A piece of labor legislation gave government the power to the states to pass “right-to-work” laws.
Right-to-work laws outlaw union membership as a precondition of employment.
7. c. The Landrum-Griffin Act was a response to allegations of corruption and misconduct by union
officials.
8. d. The input-substitution effect states that an increase in the wage increases the cost of labor relative
to the cost of capital, and the firm will substitute capital for labor, reducing the quantity of labor
demanded.
9. b. Rather than accepting such a large reduction in union employment, truckers accepted a wage of
$14 per hour, and total union employment in 1996 was 439,000. In other words, union truckers
accepted lower wages in exchange for more jobs—or a smaller reduction in jobs.
10. b. If labor is responsible for a relatively large fraction of production costs, an increase in the wage
will cause a larger increase in the product price than if it were a small fraction. If demand for the
output is relatively elastic then a change in price causes a larger decrease in output than if demand
were inelastic, and thus a larger decrease in the quantity of labor demanded.
11. c. Labor unions try to increase wages by imposing work rules that increase the amount of labor
required to produce a given quantity of output—a practice called featherbedding.
12. a. According to the textbook, unions may increase worker productivity by facilitating communication
between workers and managers. Also, unions lower turnover among workers.
13. b. This is the principle used in economics to determine the optimal level of an activity. The firm
chooses the quantity of labor at which the marginal benefit of labor equals the marginal cost.
14. a. A monopsonist faces a positively sloped market supply of labor. To hire more workers, the
monopsonist must pay a higher wage, so the marginal labor cost exceeds the wage.
15. b. A monopsonist (a single buyer) uses its market power to decrease the wage or other input prices.
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16. c. The marginal labor cost equals the wage paid to new worker + (change in wage x quantity of
original workers). In this case: 24 + (4 x 7) = $52.
17. a. The labor supply curve indicates that to hire 40 workers, the monopsonist must pay a wage of $4.
18. c. With a minimum wage, the supply curve is horizontal at the minimum wage up to the point where
it intersects the original supply curve and then follows the original supply curve upward.
19. c. To hire more workers, the firm must pay a higher wage. Most workers will receive a wage that
exceeds the opportunity cost of their time, so each worker gets a producer surplus.
20. b. The firm must increase its wage in order to attract more high-skill workers.
21. There is asymmetric information in the labor market because employers cannot distinguish between
skillful and unskillful workers, or between hard workers and lazy workers. If the employer cannot
distinguish between different types of workers, it will pay a single wage, realizing that it will
probably hire workers of each type.
22. Paying efficiency wages is the practice of paying higher wages than average in order to increase the
average productivity of the workforce. Firms pay efficiency wages to attract high-skill workers. The
employer must pay a wage that exceeds the opportunity cost of high-skill workers. As the firm
attracts more skilled workers, the average productivity of the workforce rises. By paying efficiency
wages, the firm attempts to increase the average productivity of its workforce, and therefore its profit.