Imperfectly Competitive Labour Market

In the real world, labour markets are not perfectly competitive. Their imperfections make them imperfectly competitive. But, what is an imperfectly competitive labour market? How are wages and employment levels determined in this kind of labour market? You will find the answers to these questions in what follows and you will also learn which factors influence an imperfect labour market. 

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Table of contents

    Imperfectly competitive labour market: characteristics

    An imperfectly competitive labour market is very different to a perfectly competitive labour market. In a perfectly competitive labour market, there are many firms offering similar or identical jobs. Workers in this labour market have similar skills. Firms are wage takers, meaning that they pay their workers based on the equilibrium wage.

    The imperfect labour market is the opposite of a perfectly competitive labour market and reflects the real world more realistically.

    An imperfectly competitive labour market is a labour market where either the firms or workers have the power to influence wages. In this market firms or workers are wage makers.

    The main characteristics of an imperfect labour market are:

    • Competition.
    • High barriers to entry and exit.
    • Different products.
    • A small number of buyers and sellers.

    Imperfect labour market examples

    There are many examples of imperfection in labour markets. These imperfections are what cause either the workers or employers to determine wages in the labour market. Let’s consider three of these imperfections:

    1. Monopsony power.
    2. Trade unions.
    3. Imperfect information.

    Monopsony power

    Monopsony power gives firms in the labour market wage-setting powers.

    Monopsony power is the power of the employer who is the single seller in the labour market.

    Due to the firm’s monopsony power, it can set the wages and limit the number of workers. Since employees have no alternatives, they must accept the wage the employer offers.

    We will look at this particular imperfection in more detail later on.

    Trade unions

    Trade unions help the members of the union to negotiate with their employers and get benefits and better working conditions. Unions give workers in the labour market wage-setting powers.

    Trade unions are groups of people (employees/workers) who come together to protect their best interest.

    Unions usually bargain for wages by going on strike or campaigning. Trade unions are particularly beneficial when they operate in an industry with a monopolistic employer or where the demand for labour is inelastic.

    Imperfect Information

    No market is perfect, and this is true for the labour market as well. There may be insufficient information or inaccurate information between employers and employees and this can result in friction and market failure in the labour market.

    This can either result in firms or workers having the power to determine wages and employment.

    Wage determination in an imperfectly competitive labour market: monopsony labour market

    As we mentioned previously, when there is a monopsony employer in a labour market, the firm has wage-setting powers. In this situation, the labour force is exploited by employers and the relative wage level of an employee is often much lower than the firm’s marginal revenue product (MRP).

    In the figure below, we will see how wages are determined in the monopsony labour market and how the monopsony power impacts the wage rate.

    In a perfectly competitive labour market, wages are determined by the equilibrium rate set by the whole industry. Each firm in the industry, then, adopts this wage.

    In an imperfectly competitive labour market where one monopsony exists, they set their own wage. You can see this in Figure 3 below.

    imperfectly competitive labour market wage determination studysmarterFigure 3. Wage Determination Imperfectly Competitive Labour Market, StudySmarter Original

    In Figure 3, the workers in this labour market should be paid We, where MC = MRP. However, the monopsony exploits them and chooses to pay them Wm. The wage Wm is far below the wage they are worth, thus the green shaded area is the area of exploitation.

    Trade unions are beneficial in markets like this one as they can pressure firms to pay their employers a higher wage, W1. Although this is still below what workers are actually worth, it is 'fair' compensation.

    Employment determination in an imperfectly competitive labour market: monopsony labour market

    Figure 3 above shows us another aspect monopsonies can control in the labour market: employment levels.

    Not only can the employer pay their workers a lower wage, but they can also restrict the level of employment. Since they are the only employer in the industry, their monopsony power allows them to employ fewer people at a lower wage.

    Thus, the demand for labour in an imperfect market is well below the equilibrium level.

    Reasons for wage differences in imperfectly competitive labour markets

    We have considered how an imperfectly competitive labour market causes wage differences. Other factors that can cause a difference in wages across the labour market are:

    • Supply. If there is a limited supply of workers but high demand for them, workers in this industry tend to be paid a higher wage.
    • Geographical differences. Workers in London compared to workers in Sheffield will be paid a higher wage even if they may do the same job. This is could be due to the higher cost of living in London and the difference in demand for labour in London.
    • Skill. Higher-skilled workers will be paid more than lower-skilled workers because employers are more willing to compensate fully for their skills.

    Imperfectly Competitive Labour Markets - Key takeaways

    • An imperfectly competitive labour market is a market where either the firms or workers have the power to influence wages.
    • The concept of an imperfectly competitive labour market is more realistic than a perfectly competitive market.
    • There are many factors in an imperfect labour market, such as monopsony power, trade unions, and imperfect information that cause imperfections in this labour market.
    • When a monopsony employer exists in a labour market, the firm has wage-setting powers and they exploit their workers by paying them a lower wage.
    • Monopsonies can also control employment rates in an imperfectly competitive labour market.
    • Trade unions help their members negotiate with their employers and get benefits and better working conditions. Unions give workers in the labour market wage-setting powers.
    Frequently Asked Questions about Imperfectly Competitive Labour Market

    What is an imperfectly competitive labour market?

    An imperfectly competitive labour market is a market where either the firms or workers have the power to influence wages. In this market firms or workers are wage makers.

    What are some imperfections in a labour market?

    Some imperfections in a labour market are:

    1. Monopsony power.
    2. Trade unions. 
    3. Imperfect information.
    4. Geographical immobilities. 
    5. Discrimination.

    What are some characteristics of an imperfectly competitive labour market?

    Some characteristics of an imperfectly competitive labour market are:


    • Firms are wage markers.
    • Many firms offer different types of jobs.
    • Workers have different skills.

    Test your knowledge with multiple choice flashcards

    Who has wage-setting powers when there is a monopsony employer in a labour market?

    Where do monopsony employers set their workers’ wages?

    Which labour market is more realistic?

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