Wage Determination: Employer Monopsony and Union Monopoly

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Wage is compensation paid to a worker by the employer for services rendered.Theoretically it is based upon how much value the worker adds to the product produced. But practically it is impossible to measure it and separate it from the values added by the other three factors of production: land, capital, and entrepreneurship. Also in case where the entrepreneur is self-employed it is all the more difficult to separate the value added as a worker from value added as the entrepreneur.

Under purely competitive labor market where millions of identical workers are competing for millions of identical jobs offered by millions of employers, the wage would be determined by the supply of and demand of workers.  When there too many workers and too few job, supply of labor exceeds the demand for them, the wages tend to fall even for the most highly educated and skilled workers.  However, when there are too many jobs but too workers available, the wages tend to rise.  That is when the employers offer "sign-in" bonus and stock options to recruit workers.

The labor market is not homogeneous.  The demand for and supply of workers differ from industry to industry.  Moreover, the economy goes through what is called "business cycles"

that influences the availability of jobs and wages.  This will be discussed in an other article.

Since pure competition is only a theoretical and assumed situation, the determination of wage depends upon the nature of the labor market.

Monopsony is a market similar to a monopoly except that a largebuyer, not seller, controls a large proportion of the market and drives the prices down. Sometimes referred to as the

buyer's monopoly.  When the following conditions exist in a resource market, it is characterized as pure monopsony:

  1. A firm is the single buyer of an input-for example, the only employer of farm workers in the area.
  2. The owners of the input, workers in our model, have no choice but to negotiate with that single firm (employer) since there are no other job opportunities in the area.
  3. The firm is able to maintain complete secrecy about its business practices.
  4. No other firm is able to enter the market to compete for the purchase the resource in question (farm workers).

If and when these conditions are met, the firm has complete market power and becomes a price maker.  It can offer any price for the resource it is buying.  However, if enough units of the resource are not available at that price, it must keep raising the price to buy the optimum (profit maximizing or loss minimizing) quantity of the resource.

 In our model we assume the following:

  1. Our firm is a monopsony-the only employer of farm workers in the area.
  2. As a seller of its product (corn) it is facing perfect competition since corn is being shipped from other parts of the country to the local market.
  3. It will increase its output of corn by increasing only one input-farm workers (labor).
  4. It is in the short run and the law of Diminishing Returns sets in from the very beginning.

Under the above assumptions the employer would pay the wage equal to the value added (called the marginal revenue product) by the last worker employed.  That value practically exceeds the wage  that worker and all the rest of the workers employed would be paid.  Thus, a monopsonist-the only employer-is able to maximize the firm's profits by paying wages far less than they deserve.  It means they are being exploited for their weak bargaining power.  The workers, therefore, to create a countervailing power, form a union.

Bilateral Monopoly:

A market that has only one supplier (labor union) and one buyer (employer). The one supplier (labor union) will tend to act as a monopoly power, and try to negotiate for the highest possible wage.  The lone buyer (employer), on the other hand,  will look towards offering a wage that is as low as possible. Since both parties have conflicting goals, the two sides must negotiate based on their relative bargaining power with a final wage settling in between the two sides' offers on the table.

In order to maintain a balance between the economic powers of large corporations and equally powerful labor unions, there are federal and state laws that govern their behavior.  The laws about minimum wage, unemployment insurance, civil rights, affirmative action, etc. are examples that are considered pro-labor and anti-business.  But there are also laws that restrict union activities and provide businesses tax shelters, and help larger corporation merge easily to gain even greater market power.

Natural Monopoly:

A type of monopoly that exists as a result of the high fixed or start-up costs of operating a business in a particular industry. Because it is economically sensible to have certain natural monopolies, governments often regulate those in operation, ensuring that consumers get a fair deal.

The utilities industry is a good example of a natural monopoly. The costs of establishing a means to produce power and supply it to each household can be very large. This capital cost is a strong deterrent for possible competitors. Additionally, society can benefit from having natural monopolies because having multiple firms operating in such an industry is economically inefficient.


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