Here is an elaborated discussion on the determination of wages under imperfect competition.
The Demand for Labour under Monopoly:
We now consider the demand for labour by a firm which has monopoly in the output market. Since in monopoly MR < P, MRPL is less than VMPL. However, we continue to assume that there is perfect competition in the labour markets so that MFCL = the price of labour.
In Fig. 26.1 the MRP curve of labour lies below the VMP curve. This is because VMP = P. MPPL and MRPL = MR.MPPL. It is clear that for a given wage rate, the monopolist will hire less labour than if he behaves like a competitor. The reason is that the monopolist produces less output than would be produced under competition. So fewer units of labour are used.
In short, a monopolist will hire labour up to the point where MRPL equals the wage rate. And it will employ extra labour so long as revenue per worker exceeds the wage rate and will stop where MRPL = wage rate. And a portion of MRP curve which lies below the ARP curve (not shown here) is the demand curve the labour.
Two Variable Factors:
So long we derived the demand curve for labour holding the levels of other inputs constant. We shall now consider the case of two variable factors: labour and capital. The monopolist will employ labour and capital to the point where the MRP of each factor is equal to the price of the factor. Thus it reaches equilibrium (or the point of optimum purchase of labour and capital) where the MRP of each factor is equal to the price of the factor.
Thus in equilibrium we have:
MRPL = MR.MPPL = PL
and MRPK = MR.MPPK = PK
Thus we get
PL/MPL = PK/MPK = MR (by substituting MPP by MP of both L and K) or, Price of labour/ Marginal product of labour = Price of capital/ Marginal product of capital = marginal revenue.
The first equality is the same as under perfect competition. However, the difference is that this ratio is equal to price under perfect competition but is equal to marginal revenue under monopoly.
Thus we have:
PL/MPL = PK/MPK
These relations do not, however, give us the demand function for labour when capital is variable. To get this we have to vary the usage of capital along with labour as we have done in the context of labour demand under perfect competition. The only adjustment required is that the VMP curve is to be replaced with the MRP curve.
Industry Demand Curve for Labour:
It may be noted that no complication is involved in deriving the industry demand curve in monopoly because the firm itself is the industry. So the monopolist’s demand curve for labour is the industry demand curve for labour. This point may now be briefly explained.
In case of perfect competition we cannot derive the industry demand curve for labour just by horizontally adding up the demand curves of labour of individual firms. This is because with a fall in the price of the product, each firm expands employment, the industry employment rises, the industry output expands and, hence, the product price falls and VMP changes.
This is why we have to take account of the change in product price while deriving the industry demand curve for a variable factor (such as labour). A similar problem does not arise in case of monopoly since the monopolist’s demand curve is the industry demand curve for labour.
Monopsony in the Labour Market:
Now we assume that there is monopoly in the labour market, i.e., only one buyer of labour. Just as a monopolist has to reduce the price to sell more a monopsonist has to pay extra wage to attract extra workers. This means that the monopsonist faces an upward sloping supply curve of labour (which is also the market supply curve).
Now the marginal factor cost of labour is not equal to the price of labour (as MR is not equal to price under monopoly). With upward sloping labour supply curve, MFC exceeds the price of labour or the wage rate. And the monopsonist maximises profit by hiring labour up to the point where MFC = MRP. (And, of course, MRP = VMP with a competitive output market).
Table 26.1 shows how MFC is calculated. The average factor cost AFC is the same as the price of labour (wage rate). The MFC and AFC figures are plotted in Fig. 26.2.
Relationship between AFC and MFC:
The relationship between AFC and MFC for labour is expressed as:
MFC /AFC = 1 + 1/eL or MFC = w (1 + 1/w).
where w is the wage rate of the price of labour and ,, is the elasticity of labour supply. This may now be proved very easily.
In the short run TFC = w.L
dTFC = w. dL + L.dw
MFC = dTFC/dL = w + L.dw/dL = w [1 + L/w.dw/dL] = w [1 + 1/eL]
Since w = AFC, we have MFC/AFC = 1 + 1/eL
With a competitive labour market, the individual firms eL is infinite and. hence, MFC = AFC = w. With imperfect market 0 < eL < ∞ and MFC > AFC (except where labour supply curve is backward bending in which case MFC < AFC became eL < 0).
Absence of Demand Curve:
As the monopolist has no supply curve for its product the monopsonist has no demand curve for labour or, to be more accurate, the demand curve consists of a single point. The concept of labour demand curve loses it relevance because the monopsonist is not a price taker. It determines the price of labour by the quantity that it employs. For a given labour supply curve, i.e., the AFC curve, the MFC curve is determined.
The intersection of the MFC curve with the VMP curve (in the case of perfect competition in the output market) or the MRP curve (in the case of monopoly) uniquely determines the quantity of labour employed the wage rate is then determined from the supply curve of labour or the AFC curve. This point is illustrated in Fig. 26.3. Here Ls is the supply curve of labour, MFC is the marginal factor cost curve, and VMP is the value of the marginal product of labour. In Fig. 26.3 the level of employment (L) is determined by the intersection of the VMP and MFC curves (The output market is assumed to be competitive).
Once L is determined the wage rate w is determined from the supply curve as the wage rate corresponding to the employment L. We know that under perfect competition the wage rate is equal to VMPL. Under monopsony it is below the VMP. Joan Robinson called this difference the monopolistic exploitation of labour. However, by forming trade unions, workers can counter this exploitation.
Trade unions act as monopoly suppliers of labour and pose a threat to the monopsonist power of employers. They are mainly concerned with the relative pay of members. The theory of the monopoly power of the trade union directs attention to the elasticity of substitution between the members labour and other factors of production, and to the elasticity of demand for the product.
However, much depends on the possibility of labour being substituted by capital and of the trade union gaining control of this. It is in the firms and industries themselves most strongly placed in the market, and able to retain adequate profit margins, that trade unions are likely to maintain levels of Pay above those obtaining elsewhere for similar grades of labour. As for the demand for labour of a firm the main points of difference between perfect competition and monopoly are shown in Table 26.2.
The labour market is perfect the effect of minimum wage law is to create unemployment. However, under monopsony the minimum wage law can increase the wages of workers without any fall in employment and can even increase employment in some situations. These possibilities may now be explored one by one. In Fig. 26.4 the labour supply curve is Ls and the MFCL curve lies above this. Now suppose a minimum wage is fixed at w̅. Since no labour is supplied at a wage below w̅, the supply curve of labour becomes efLs.
Since the wage rate is constant over the range ef, MFCL is the same as the wage rate. At point f, the MFC is the same as it was before. However, the MFC curve becomes efg MFC with the imposition of a minimum wage.
With a minimum wage, the MFCL curve is flat until it intersects the supply curve. After this the MFCL curve becomes vertical and meets the original MFCL curve. In this case employment is determined by the intersection of the MFCL curve with the VMPL curve, and wages from the supply curve or all possible combinations of wage and employment are bounded by these two curves, as shown in Fig. 26.5. See the two dotted lines ELs and EF.
In Fig. 26.6 ab measures monopsonistic exploitation. If the minimum wage w̅ is fixed at a level higher than w1, where w1 is the wage prevailing under monopsony, as shown in Fig. 26.6, the level of employment will rise.
Here the initial level of employment is L1 and the wage rate w1. If the minimum wage is fixed at w̅, the MFCL curve is efgMFCL. At the point of intersection of the MFCL curve with that VMPL curve (point e’), the level of employment rises to L2. The wage rate w is determined from the supply curve efLs.
Effects of different levels of the minimum wage:
In Fig. 26.7 L1 is the level of employment and w1, is the wage rate in the initial situation (i.e., in the absence of minimum wage law). At this level of employment the VMPL of labour is wm. The degree of monopsonistic exploitation in wm – w1. If the minimum wage is fixed at wm, then employment will remain unchanged and the wage rate will be wm. Thus, with minimum wage at wm, all monopsonistic exploitation is removed.
The maximum employment that can be created by setting the minimum wage at w0 is L0, the intersection of the VMP curve with the supply curve of labour. However, if minimum wage were fixed between w1 and wm employment and wages will both rise above what would otherwise have prevail under monopsony. Setting minimum wage above wm will increase wages but will reduce employment below L1. But if the minimum wage is set below w1 there will be no effect.
In short, the effect of minimum wage laws in a competitive labour market is to reduce employment or increase unemployment. If labour markets are monopsonistic in nature, the effect may be increased employment.
Minimum wage laws affect only that part of the labour market which is competitive Monopsony elements are likely to exist in the labour market but at the higher end of the skill levels of the labour force. Workers at these levels are not at all affected by minimum wage laws. They are more affected by trade union activity.