The Monopsony Model

One of the standard models that explains positive employment effects given an increasing wage is the monopsony model. A firm has monopsony power if they are the only, or one of few, buyers of labor in a market.⁵ Unlike a competitive market for labor (See figure 2), where firms take the wage level as fixed, a monopsonist affects the equilibrium wage based on how many workers they hire. Consider the monopsony model in figure 3. As always, firms choose their equilibrium wage and quantity of laborers by setting $MRP_L = MC_L$. This intersection determines $L_*$. For the firm to hire an additional worker, they must raise the wage to attract more workers. However, they must raise the wage not only for that worker, but for all those already employed. Thus $MC_L$ is upward sloping and above $S_L.$ Based on $L_*$, the monopsonist does not have to pay a wage equal to $MC_L(L_*)$. Instead, they only have to pay a wage $w_*$, which is the wage corresponding to $S(L_*).$ Once a minimum wage is instated, $MC_L = w_{min}$ up until the intersection with $S_L.$ We reach a higher level of employment at $L'.$ The problem with a monopsony explanation for the above findings is that a monopsony is very rare. Hardly ever will one find a market where one firm is the sole buyer of labor. The restaurants in the fast food industry that Card and Krueger analyzed might have had some monopsony power due to being the largest employer of low-wage workers, but they would not have been a true monopsony. In order for a wage increase to cause an employment gain, the price of the output product must rise to cover the cost. Since this did not happen in the New Jersey restaurants, the monopsony model solution is not sound.