Monopsony: Why Marginal Factor Cost Exceeds the Wage

You’ll be able to

Explain why a monopsonist faces a marginal factor cost above the labor supply curve
Compute marginal factor cost from a labor supply schedule
Locate the monopsony wage and employment level on the graph

A single buyer must raise the wage for everyone

A monopsonist is the only significant buyer of a factor — a hospital in a small town, a single mill in a company town. It faces an upward-sloping labor supply curve, so to hire one more worker it must offer a higher wage, and it must pay that higher wage to every worker already employed. So the true cost of the extra worker is their wage plus the raise given to all the others. That total is marginal factor cost, and it lies above the supply curve.

Marginal factor cost

MFC = Δ(total labor cost) / Δ(workers) · MFC > wage for a monopsonist, MFC = wage in a competitive labor market

The exact structural parallel to marginal revenue for a monopolist: MR < price because of the price cut on all units; MFC > wage because of the raise on all workers.

The hiring decision, then the wage

The monopsonist hires where MRP = MFC — that determines the quantity. It then pays the lowest wage that will attract that many workers, which is read off the supply curve at that quantity. So the wage is below MRP, and both employment and the wage are lower than they would be in a competitive labor market. The two-step structure is the exact mirror of the monopoly graph, where quantity comes from MR = MC and the price comes from demand.

Computing MFC from a schedule

For each number of workers, compute total labor cost as wage × workers, then take the row-to-row difference. The result rises faster than the wage does. A worked example makes the size of the gap concrete: it is not a small correction, and students who assume MFC is approximately the wage get monopsony questions badly wrong.

Worked example

A monopsonist faces this supply: 1 worker at $10, 2 at $12, 3 at $14, 4 at $16. Compute total labor cost and MFC, then find employment and the wage if MRP is 24, 22, 20, 18.

1.Total labor cost: 1 × 10 = 10; 2 × 12 = 24; 3 × 14 = 42; 4 × 16 = 64.
2.MFC: 10, then 24 − 10 = 14, then 42 − 24 = 18, then 64 − 42 = 22.
3.Compare MRP with MFC: worker 1 (24 vs 10) hire; worker 2 (22 vs 14) hire; worker 3 (20 vs 18) hire; worker 4 (18 vs 22) do not.
4.So hire 3 workers. The wage needed to attract 3 workers is $14, read off supply.
5.Note MRP of the third worker is $20 while the wage is $14 — a $6 gap.

Answer: Hire 3 workers at a wage of $14. The wage is well below the third worker's MRP of $20, which is the monopsonistic wage gap — and note MFC of $18 for that worker is nearly double the $10 wage of the first.

Watch out

The monopsonist pays the wage from the supply curve, not from MFC. MFC determines how many to hire; supply determines what to pay them. Reading the wage off MFC overstates it and is the standard error on this graph.

Checkpoint

A monopsonist's marginal factor cost exceeds the wage because:

Checkpoint

Compared with a competitive labor market, a monopsonist employs:

Checkpoint

A monopsonist hires where MRP = MFC. It sets the wage by reading:

On the exam

Label four things on a monopsony graph: MRP, supply, MFC, and the chosen quantity. Then mark the wage on supply and MRP directly above it — the vertical gap between them is the monopsonistic exploitation the question will ask you to identify.

Answer the 3 checkpoints as you read.