Labor Market Dynamics: Monopsony vs. Perfect Competition
In a perfectly competitive labor market, the supply curve of labor to firms facing job seekers is a horizontal line at the level of wages. Their hiring decisions do not influence the market wage. However, in the case of a monopsony, the labor supply curve is the labor supply curve in the market itself. Let us assume that this curve is upward sloping, as shown in the chart below:
A supply curve is also called the average cost of factors (ACF), and it indicates the average amount per employee to be paid for each level of employment. As the costs of the product total employment level of employment at the average cost function, the marginal factor cost (MFC) is also a straight line, having the same intercept and twice the slope of the line of ACF. The following chart shows the level of wages and steady employment in a monopsony.
The labor demand curve of the monopsonist is obtained the same way as any other company. If the market for their products is perfectly competitive, the demand for labor will be the marginal revenue product of labor (MRPL). The optimal level of employment will be one in which MFC and MRPL = value of the marginal product of labor (VMPL) are equal, which is L*. The projection of this point on the supply curve is W*. If, instead of a monopsony, a market were to work in a competitive manner, the optimal labor demand would amount to L**, which is the point at which demand intersects the supply curve in the chart below:
Equilibrium in a monopsony is inefficient relative to the situation of perfect competition because when the employment level is L*, workers are willing to offer an extra hour of work in exchange for only W*, while the additional revenue that the unit would generate would be MFC*. In a monopsony, wages are lower than under perfect competition, leading many critics of monopsony to accuse it of being a system that exploits workers. But if this were a true situation of exploitation, it could not be maintained for long because if a company in a certain area paid much less than the value of what their workers produce, other companies could enter the area and compete upwards for the services of these workers.
Production Possibility Frontier and Economic Efficiency
Point OV represents the maximum amount of food that our economy is capable of manufacturing (275 units) when we use all its resources (100 work units and 50 of capital). OA is the diametrically opposite point; it is the maximum amount of clothing that our economy is capable of producing using all its resources on it. The intermediate points E, F, and G represent the combinations of food and clothing products that are isoquants marked on the contract curve of the production box.
The production possibility frontier (PPF) is defined by the quantities of products that an economy can produce efficiently with existing technology at that particular time. The slope of the production possibility frontier at any point is called the marginal rate of transformation (MRT) at that point and measures the opportunity cost of clothing in terms of food (MCC / MCF). It does not mean that a certain amount of clothing can be transformed into another food, but that if part of the resources (K and L) we used in clothing manufacture was moved to the manufacture of food, the production of the first would diminish, and the second would increase.
For an economy to be efficient in the combination of the products it manufactures, it is necessary that the marginal rate of substitution (MRS) of each consumer is equal to the marginal rate of transformation. Recall that the MRS of Bruno and Anna in the balance of maximum satisfaction should be equal and equal to the ratio of prices PC* / PF*. At the same time, remember that the MRT was equal to the ratio of marginal costs MCC / MCF. We also know that the equilibrium condition of competitive producers of food and clothing was that commodity prices were equalized to the values of marginal cost: PF* = MCF and PC* = MCC. If we divide these two equations, we have: PC* / PF* = MCC / MCF, implying that the ratio of prices of products of equilibrium is equal to the marginal rate of transformation.
In short, an economy that is in terms of competitive general equilibrium is efficient (Pareto optimal) in consumption, production, and choice of product mix. Now, that the allocation is Pareto optimal does not mean it is a good society. The final balance depends on the initial allocations, and if it is not fair, we should expect that the final balance will not be either.