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Chapter 16: Problem 8

A monopsonist buys labor for less than the competitive wage. What type of inefficiency will this use of monopsony power cause? How would your answer change if the monopsonist in the labor market were also a monopolist in the output market?

Short Answer

Expert verified
The use of monopsony power causes allocative inefficiency as fewer employment opportunities are created and workers are paid less than their marginal productivity. If the monopsonist is also a monopolist in the output market, it leads to a double inefficiency, with reduced consumer welfare due to higher prices and reduced employment opportunities.

Step by step solution

01

Understanding Monopsony

A monopsony is a market situation where there is one buyer but many sellers. In the context of the labor market, a monopsonist is the sole employer in a market who has the power to influence the wage rate by altering its demand for labor.
02

Identifying the Inefficiency caused by Monopsony

When a monopsonist buys labor for less than the competitive wage, it results in an allocative inefficiency. Allocative inefficiencies occur when goods or resources are either under or overconsumed or produced, and in this case, it means that labor is underconsumed, i.e., there are fewer employment opportunities, and workers are paid less than their marginal productivity.
03

Analyzing the Situation If Monopsonist is a Monopolist in Output Market

If the monopsonist in the labor market were also a monopolist in the output market, this would result in a double inefficiency. This is because this firm will restrict output to maximize profits, which leads to higher prices and reduced consumer welfare, just like a normal monopolist. At the same time, it will not employ as many workers, for the reasons outlined previously.

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