Question

A monopsonist's marginal factor cost $(MFC)$ curve lies above its supply curve because the firm must a. increase the price of its product to sell more. b. lower the price of its product to sell more. c. increase the wage rate to hire more labor. d. lower the wage rate to hire more labor.

Short answer

The correct answer is: $c.$ Increase the wage rate to hire more labor. This is because a monopsonist needs to increase the wage rate for all workers in order to hire more labor, and this results in a higher marginal factor cost, causing the MFC curve to lie above the supply curve.

Step-by-step solution

Understanding Monopsony

A monopsony is a market situation where there is only one buyer (monopsonist) for a certain good or service. In this case, we are talking about a monopsonist as a buyer of labor. Since the monopsonist is the only buyer of labor, it has market power and can influence the wage rate.

Marginal Factor Cost (MFC) Curve

MFC is the additional cost of hiring an additional unit of labor. In a monopsonistic labor market, to hire more labor, the monopsonist needs to increase the wage rate for all workers. This causes the MFC curve to be upward sloping as the firm hires more labor.

Supply Curve

The supply curve represents the relationship between the quantity of labor supplied by workers and the wage rate offered by the monopsonist. When the wage rate offered increases, the quantity of labor supplied by workers also increases, as more workers are willing to work at a higher wage rate. This curve is also upward sloping.

Comparison of MFC and Supply Curves

Since the monopsonist must increase the wage rate not only for the additional workers it wishes to hire but also for the existing ones, the MFC curve will lie above the supply curve. Now, let's look at the given options and choose the correct one:

Option a. Increase the price of its product to sell more

This option is not related to why the MFC curve lies above the supply curve for a monopsonist, as the question is about the cost of hiring labor, not about selling products.

Option b. Lower the price of its product to sell more

Similar to option a, this option is also not relevant to the relationship between the MFC and supply curves, as it is related to selling products rather than hiring labor.

Option c. Increase the wage rate to hire more labor

This is the correct option. To hire more labor, the monopsonist must increase the wage rate for all workers, which results in a higher marginal factor cost. This is why the MFC curve lies above the supply curve for a monopsonist.

Option d. Lower the wage rate to hire more labor

This option is incorrect because lowering the wage rate would lead to a decrease in the quantity of labor supplied, not an increase. So, the correct answer is: c. Increase the wage rate to hire more labor.

Key concepts

Marginal Factor Cost Curve

In understanding the dynamics of a monopsony labor market, the marginal factor cost (MFC) curve plays a critical role. The MFC represents the added cost that a firm incurs when hiring an additional worker. In simpler terms, it is the extra amount that a monopsonist must pay for each additional unit of labor.

The essence of the MFC curve being above the supply curve of labor arises from the unique nature of a monopsonistic market. Unlike a competitive market where hiring more workers does not require changing the wage rate for current employees, a monopsonist, as the sole buyer of labor, must offer a higher wage to attract more workers. This increased wage applies to all employees, not just the new hires. As a result, the cost of hiring each additional worker is more than the previous one because it includes the increased wages for all existing workers.

To depict this mathematically, let's say the initial wage rate is $W_0$ for $N_0$ workers. To hire one more worker, if the wage rate becomes $W_1$, the monopsonist now pays $W_1$ for all $N_0+1$ workers. The additional cost, therefore, is not merely $W_1$ but $(N_0+1)\times W_1-N_0\times W_0$, which exemplifies why the MFC curve rises more steeply and lies above the labor supply curve.

Supply Curve of Labor

The supply curve of labor in the context of a monopsony market illustrates the relationship between the wage rate and the number of workers willing to work. It is upward sloping, indicating that higher wages entice more individuals to enter the labor market or encourage existing workers to offer more hours.

It's crucial to differentiate the responses in labor supplied at different wage rates. When a monopsonistic employer offers a slight wage increase, only a few additional workers may decide to work. However, substantial wage increases might draw a significantly larger number of workers. This relationship is captured by the slope of the supply curve.

Workers, on the whole, have varying levels of minimum acceptable wages—a concept known as reservation wages. As the offered wage rate rises, it surpasses the reservation wages of more workers, thus extending the workforce. The supply curve encapsulates these personal economic decisions and projects the collective willingness to work at various wage levels.

Wage Rate in Monopsony

The wage rate in a monopsonistic labor market is a central concern for both workers and the monopsonist. In a monopsony, since one firm constitutes the entire demand for labor, it wields significant power over setting wages. Contrary to competitive markets where firms are wage takers, a monopsonist is a wage maker—it decides the wage rate that prevails in the market.

However, this power to set wages comes with a strategic dilemma. To attract more workers, the monopsonist must raise the wage rate. But since the same rate must be paid to all employees, hiring additional labor becomes increasingly expensive. Thus, the monopsonist aims to balance the marginal benefits of more labor (additional output produced) against the marginal factor costs.

The resulting wage rate is typically lower than in competitive markets where multiple employers vie for workers. These employers in competitive markets drive wages up to the equilibrium where supply meets demand. In contrast, the monopsonist capitalizes on its market power to set wages at a lower level, maximizing profit while still maintaining a workforce.