Imperfectly Competitive Markets for Factors of Production
I. The Demand for Factors of Production When Factor Markets Are Perfectly Competitive
A. Factor Demand in Perfect Competition: A Review
1. To maximize profits, a firm hires additional units of a factor up to the point that the factor’s marginal revenue product (MRP) equals
its marginal factor cost (MFC).
2. The firm’s MRP curve is its demand curve for the factor.
3. MRP equals marginal product times price.
4. In a perfectly competitive market, the price of a factor of production equals the MRP ofthe factor and also MFC.
B. Factor Demand in Imperfectly Competitive Product Markets
1. The maximizing rule for competitive firms and imperfectly competitive firms is the same: equilibrium will be reached where the
MRP and MFC curves intersect.
2. The downward-sloping demand curve of an imperfectly competitive firm means that marginal revenue will be less than price.
3. In an imperfectly competitive firm, MRP is marginal product multiplied by marginal revenue.
II. Price-Setting Buyers: The Case of Monopsony
A. Basic Concepts
1. A market in which there is a single buyer of a good, service, or factor of production is called a monopsony.
2. A firm can set the price in a factor market if it faces an upward-sloping supply curve for the factor.
3. A price-taking firm in a factor market can hire any amount of the factor at the market price. It faces a horizontal supply curve for
the factor at the market-determined price.
4. A price-setting firm in a factor market can obtain a larger quantity of the factor only by offering a higher price.
B. Monopsony Equilibrium and the Marginal Decision Rule
1. The marginal decision rule, as it applies to a firm’s use of factors, calls for the firm to add more units of a factor up to the point that
the factor’s MRP is equal to its MFC.
2. The profit-maximizing quantity is determined by the intersection of the MRP and MFC.
3. The factor receives a payment that is less than its MRP.
C. Monopoly and Monopsony: A Comparison
1. Both types of firms are price setters. The monopoly is a price setter in its product market. The monopsony is a price setter in the
factor market in which it has monopsony power.
2. For a monopoly, marginal revenue is less than price. For a monopsony, marginal factor cost is greater than price.
3. Both types of firms follow the marginal decision rule. Both firms set prices at which they can sell or purchase the profit-maximizing
4. The monopoly sets its product price based on the demand curve it faces. The monopsony sets its factor price based on the factor
supply curve it faces.
D. Monopsony in the Real World
1. Although cases of pure monopsony are rare, there are many situations in which buyers have a degree of monopsony power.
2. A buyer has monopsony power if it faces an upward-sloping supply curve for a good, service, or factor of production.
3. Monopsonies in sports
a. If players’ salaries were determined in a competitive market, they should equal MRP.
b. If players’ salaries were determined in a market with monopsony power, they should be less than MRP.
c. Recent events (elimination of reserve clauses, strikes, and lockouts) have led to more competitive markets in sports.
4. Monopsony in other labor markets
a. A firm with a dominant position in a local labor market may have monopsony power in that market or a part of that market.
b. Examples of monopsony power locally may be hospitals over nurses or universities over part-time faculty.
5. Monopsony in other factor markets
a. Some organizations may have sufficient monopsony power to bargain for lower prices on some inputs.
b. Some examples include the DOD in weapons markets, Sears in Craftsman brand tools, HMOs in employee health plans.
c. Monopsonies are likely to pay a lower price and buy a smaller quantity of a particular product than buyers who operate in a more
competitive environment.
E. Monopsony and the Minimum Wage
1. A monopsonist employer will increase employment and raise wages if a minimum wage is imposed above the monopsony wage.
2. Even with a minimum wage, the monopsonist still employs labor up to the point that MFC equals MRP.
III. Price Setters on the Supply Side
A. Monopoly Suppliers
1. Monopoly suppliers act like any other monopoly by reducing quantity and raising price to the customers they supply.
2. Monopoly suppliers face a demand curve that represents the MRP of the factor.
B. Unions
1. A labor union is an association of workers that seeks to raise wages and to improve working conditions.
2. Collective bargaining is a process of negotiation of worker contracts between unions and employers.
3. A brief history of unions in the United States
a. The first United States unions were “workingmen’s societies” that sprang up late in the eighteenth century.
b. A closed shop is a rule that requires firms to hire only workers who belong to a union.
c. Centralization of unions began in the 1880s with the American Federation of Labor (AFL), an organization of craft unions.
d. Industrial unions such as the United Mine Workers and the United Auto Workers include membership of all who work in an
industry regardless of specific job specification.
e. Many states permit the union shop in which a firm is allowed to hire nonunion workers who are then required to join the union
within a specified period.
f. There are 21 “right to work” states that forbid union shop rules.
4. Wages and other union goals
a. Higher wages usually dominate union demands.
b. Other goals include job security, improved nonwage benefits, such as health insurance and provision of childcare, and better job
c. Increasing demand
i. In a competitive labor market, seeking a higher wage without losing employment requires an increasing demand for labor.
ii. Unions encourage investment in their human capital to increase MRP and therefore demand.
iii. Unions discourage the use of substitute factors to increase labor demand.
iv. Unions encourage the demand for products the labor produces through restriction of international trade and encouragement to buy
American goods.
5. Reducing supply
a. They can restrict labor supply growth through opposing immigration and supporting Social Security plans that encourage
b. They can restrict labor supply by creating barriers to entry to unions.
6. Bilateral monopoly
a. Bilateral monopoly occurs when a monopsony buyer faces a monopoly seller.
b. Wages in bilateral monopoly are indeterminate.
7. Unions and the economy: an assessment
a. Unions in competitive markets tend to reduce economic efficiency.
b. Unions in markets with employers holding monopsony power do not tend to reduce economic efficiency. The inefficiency has
already been created by the monopsony power of the employer.
C. Other Suppliers and Monopoly Power
1. Professional associations
a. Professional associations tend to lobby for legislation that enhances members’ economic position.
b. Professional associations may restrict supply through restrictions in training opportunities or standards for licensure.
2. Producers’ cooperatives
a. Cooperatives may act as a legal cartel.
b. Cooperatives must be given special permission by Congress to exist. Farmers cooperatives are an example.