In response (I assume) to this post of yesterday, EconTheoryChip writes to ask me why I disregard the standard textbook definition of monopsony power – namely, a situation in which an individual buyer of X faces an upward-sloping supply curve for X. If, say, McDonald’s must raise the wage that it pays its cashiers if it wishes to hire more cashiers, then, indeed, standard econ textbooks say that McDonald’s has at least a modicum of monopsony power in the labor market.
If this conclusion strikes you non-economists as odd, then recognize that if McDonald’s, in such a situation, lowers the wage it pays its cashiers, not all of its cashiers will quit working for McDonald’s. Some cashiers will quit (or reduce the number of hours they are willing to work), but not all of its workers will quit. Such ability of an employer to cut pay without causing all of its workers to quit is what passes in textbook economics for monopsony power in the labor market. Such an employer is portrayed as at least having the power to exploit its workers.
As readers of this blog know, I’m a big fan of standard, textbook supply-and-demand analysis. While I don’t believe that this analysis explains everything, I do believe that it’s capable of shedding a surprisingly bright and revealing light on an equally surprisingly vast array of human affairs. Yet my affection for standard textbook supply and demand analysis does not imply that I must, or do, hold equal affection for all other standard textbook economic models.
As is true for other scholars influenced by the Austrian tradition – a tradition that for my purposes here includes even Joseph Schumpeter – I’m convinced that modern economic theory has almost completely bungled the meaning of competition. This post is not the place for me to summarize, much less to explore in any depth, my (and other Austrians’) many complaints about the standard neoclassical analysis of monopoly and monopsony. But let me, in response to EconTheoryChip, offer a hypothetical that hints at one problem with the standard neoclassical notions of monopsony and monopoly.
Acme, Inc., is a private firm, located in Small City, USA, that hires only one kind of worker. The hourly wage for each of the (say) 100 workers that Acme employs is $10.00. This wage is such that it just barely makes it worthwhile for each of Acme’s 100 workers to keep working for Acme. Were Acme to cut its wage even to $9.99 per hour, all of Acme’s workers would quit. Some would prefer, at that lower wage, to take leisure full-time, while others would find work at some other of the several firms located in Small City. Acme in this case has no monopsony power.
One day, Acme, under pressure from the intensely competitive output market in which Acme sells its products, begins experimenting with ways to reduce its costs. In particular, Acme’s president – an ingenious garage tinkerer – devises and builds a few low-cost machines that give wonderful back and foot massages regularly to each of Acme’s employees. Acme’s employees love this new fringe benefit! Acme then cuts the hourly wage for each of its 100 employees from $10.00 to $9.75. Acme accurately calculates that the full cost to it of building and operating the massage machines is more than covered by the money it saves by cutting each of its worker’s pay by 25 cents per hour.
And it turns out that none of Acme’s employees quit as a result of the wage cut. Most employees complain, of course, but each one of these employees so greatly values the regular on-the-job massages that he or she prefers to keep working at Acme rather than to quit in order to take similar, but massage-less, jobs at other firms at the higher hourly wage of $10.00.
The above is an example in which a pay cut instituted by a firm caused none of that firm’s employees to quit. Looked at naively – that is, focusing only on the relationship between the money wage and the supply of workers – Acme here seems to have unmistakable, and sizable, monopsony power in the labor market. But clearly Acme has no such thing. If Acme had not figured out how to cost-effectively offer its employees a non-wage benefit, Acme would have lost all of its 100 workers even if it cut its hourly wage by as little as one cent. The only reason Acme here is able to cut its workers’ hourly pay and not suffer the loss of every one of these workers is because Acme devised a way to turn itself into an unusually attractive employer – so unusually attractive that people continue to willingly work for Acme even when it cut its money wage.
The take-away is that there are many different aspects of employment that workers care about – many different (as economists say) margins that reckon into any employment contract or relationship. While the money wage rate is clearly one of these margins – and, of course, it’s an unusually important margin – the money wage is emphatically not the only margin. The money wage is not the only aspect of employment that the typical worker cares about. Therefore, to conclude that an employer has monopsony power when it is observed that the employer can lower its money wage without losing all of its employees is naive in the extreme. Such a conclusion is evidence of being blinded by theory rather than having one’s vision enhanced by theory.