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.

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.

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.

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.

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.

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.

Figure 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 W_m. The wage W_m 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.