Monopsony & the Least-Cost Rule

You’ll be able to

Explain how a monopsony sets wages and employment below competitive levels
Distinguish marginal resource cost from the wage in a monopsony
Apply the least-cost combination rule for hiring multiple inputs

Monopsony: a single buyer of labor

A monopsony is a labor market with a single (or dominant) buyer of labor — a company town, or the only hospital hiring nurses in a region. Unlike a competitive wage taker, a monopsonist faces the upward-sloping market labor supply curve: to hire more workers it must raise the wage for everyone. This makes the marginal resource cost (MRC) rise faster than the wage and lie above the labor supply curve, because hiring one more worker means paying the higher wage to all previously hired workers too.

The monopsony outcome

A monopsonist still hires where MRP = MRC, but because MRC is above the supply curve, it hires fewer workers than a competitive market would. It then pays the wage read off the labor supply curve at that lower quantity — a wage below MRP and below the competitive wage. So a monopsony produces lower employment and a lower wage than a competitive labor market. This is the factor-market analog of monopoly: market power on the buying side depresses both quantity and price.

The least-cost rule for multiple inputs

When a firm uses several inputs (say labor and capital), it minimizes the cost of any output by allocating spending so that the marginal product per dollar is equal across all inputs — the least-cost combination rule. If labor’s MP-per-dollar exceeds capital’s, the firm should use more labor and less capital until they equalize. To also maximize profit, the firm hires each input until its MRP equals its price (MRP/price = 1 for every input) — a stronger condition that implies the least-cost rule as well.

Least-cost and profit-max input rules

Least-cost: MPL / PL = MPK / PK · Profit-max: MRPL / PL = MRPK / PK = 1

Equalizing marginal product per dollar minimizes cost for a given output; hiring each input until MRP = its price maximizes profit and satisfies the least-cost rule too.

Worked example

A firm uses labor and capital. Currently the marginal product of labor is 20 and the wage is $10; the marginal product of capital is 24 and the rental price of capital is $8. Is the firm minimizing cost, and if not, what should it do?

1.Marginal product per dollar of labor = MPL / PL = 20 / 10 = 2.
2.Marginal product per dollar of capital = MPK / PK = 24 / 8 = 3.
3.Compare: capital gives 3 units of output per dollar versus 2 for labor, so the ratios are unequal — the firm is not minimizing cost.
4.The firm should use more capital and less labor; as it does, MPK falls and MPL rises until the ratios equalize.

Answer: The firm is not minimizing cost: capital yields more output per dollar (3) than labor (2). It should shift toward more capital and less labor until MPL/PL = MPK/PK, at which point it produces its output at least cost.

Checkpoint

Compared with a perfectly competitive labor market, a profit-maximizing monopsonist will:

Watch out

In a monopsony, the wage is not equal to MRC. The firm hires where MRP = MRC but pays the lower wage from the labor supply curve — so wage < MRC and wage < MRP. Reading the wage off the MRC curve overstates it, a common error.

Checkpoint

A firm using labor and capital finds that MPL / wage = 5 while MPK / rental price = 3. To produce its current output at the lowest possible cost, the firm should:

On the exam

For least-cost problems, compute marginal product per dollar (MP ÷ input price) for each input and shift toward the higher one until they equalize. Do not compare raw marginal products when input prices differ — always divide by price first.

Answer the 2 checkpoints as you read.