Determining Wage Rates: Imperfectly Competitive Labour Markets (AQA A Level Economics)

• A perfectly competitive labour market is a theoretical construct
• All labour markets face some level of imperfection

Diagram: Reasons for Imperfections in the Labour Market 

Imperfections cause wages to differ from what they would be in a perfectly competitive equilibrium 

• In reality, labour market wages are not always determined according to the Marginal Revenue Product (MRP) theory
• Firms and workers have some degree of influence over wage setting
• The less competition in the labour market, the more power employers have in setting wages 

Explaining the Imperfections in the Labour Market

Imperfection	Explanation
Monopsony	A monopsony occurs when there is a single employer of labour in a market, giving the employer considerable labour market power to set wages and employment This suppresses wages in the relevant market and may lead to industrial action and ongoing labour issues in the industry E.g. The NHS is the main employer of doctors and nurses in the UK and due to a lack of competition for their labour, the government has been able to suppress their wages for many years
Trade union	A trade union is an organisation that represents people who work in a particular industry to protect their rights through collective bargaining Trade union activity can cause wages to be set above a competitive market equilibrium rate E.g. The British Medical Association (BMA) is the UK trade union for doctors and is  negotiating for better pay (2023/24)
Imperfect information	Imperfect information in the labour market occurs when employees or employers do not have the same level of information about employment, skills, or wages to make informed decisions It can lead to wage discrimination  or mismatches between skills and job requirements Depending on the type of imperfection, wage levels may end up being higher or lower than they would be if the infromation was perfectly accessible

• In a monopsony labour market, there is only one buyer of labour and wages are the same for all workers
• This is often a single large employer, which gives them significant market power
• The employer has the ability to influence both the wage rate and the level of employment
• The average cost of labour (AC_L) or supply of labour, determines the wage rate at which workers are paid
• The marginal cost of labour (MC_L) is greater than AC_L because the monopsonist has to increase the wage rate for all workers when hiring just one extra worker
• The MC_L curve includes the salary of the additional worker and also the extra money paid to all of the other workers
  • This causes the marginal cost to be greater than the average cost

Graph: Wages & employment in a monopsony labour market 

Wages are determined where MC_L is equal to MRP_L

Diagram analysis

Wage and employment levels in a competitive market

• In a competitive labour market, wages and levels of employment are determined by the intersection of demand (MRP_L) and supply of labour (AC_L)
  • This provides a wage rate of W1 and level of employment equal to E₁

Monopsonists reduce wage and employment levels

• The profit maximising level of employment for a monopsonist occurs when the MC_L = MRP_L
  • This would provide an effective wage rate of W₂ and level of employment equal to E₂
• However, due to their market power, wages can be set at a lower level
  • The monopsonist sets an effective wage rate of W₃ at the employment level of E₂
• By setting wages below the competitive level, the employer can reduce its labour costs and increase its profits