14.4 Review and Practice


Factor markets diverge from perfect competition whenever buyers and/or sellers are price setters rather than price takers. A firm that is the sole purchaser of a factor is a monopsony. The distinguishing feature of the application of the marginal decision rule to monopsony is that the MFC of the factor exceeds its price. Less of the factor is used than would be the case if the factor were demanded by many firms. The price paid by the monopsony firm is determined from the factor supply curve; it is less than the competitive price would be. The lower quantity and lower price that occur in a monopsony factor market arise from features of the market that are directly analogous to the higher product price and lower product quantity chosen in monopoly markets. A price floor (e.g., a minimum wage) can induce a monopsony to increase its use of a factor.

Sellers can also exercise power to set price. A factor can be sold by a monopoly firm, which is likely to behave in a way that corresponds to the monopoly model.

When there are a large number of sellers, they may band together in an organization that seeks to exert a degree of market power on their behalf. Workers (sellers of labor), for example, have organized unions to seek better wages and working conditions. This goal can be accomplished by restricting the available supply or by increasing the demand for labor. When a union represents all of a monopsony firm’s workers, a bilateral monopoly exists. A bilateral monopoly results in a kind of price-setters’ standoff, in which the firm seeks a low wage and the union a high one.

Professional associations may seek to improve the economic position of their members by supporting legislation that reduces supply or raises demand. Some agricultural producers join producers’ cooperatives to exert some power over price and output. Agricultural cooperatives must be authorized by Congress; otherwise, they would violate laws against collusion in the marketplace.

Concept Problems

  1. Unions have generally advocated restrictions on goods and services imported from other countries. Why?
  2. There is a growing tendency in the United States for hospitals to merge, reducing competition in local markets. How are such mergers likely to affect the market for nurses?
  3. When a town has a single university, the university may have monopsony power in the hiring of part-time faculty. But what about the hiring of full-time faculty? (Hint: The market for full-time faculty is a national one.)
  4. David Letterman earns more than $10 million per year from CBS. Why do you suppose he earns so much? Is there any reason to believe he is underpaid?
  5. Suppose a union obtains a union shop agreement with firms in a particular industry. Is there any limit to the wages the union can achieve for its workers?
  6. It is illegal for firms in most industries to join together in a producers’ cooperative. Yet such arrangements are common in agriculture. Why?
  7. In proposing an increase in the minimum wage in 2005, the Democratic Party argued that in some markets, a higher minimum wage could actually increase employment for unskilled workers. How could this happen?
  8. In 2005–06 the maximum salary of professional basketball players with up to three years of experience in the Women’s National Basketball Association (WNBA) stood at $42,000, while the maximum salary for a WNBA player in 2005 was $90,000 (the average was somewhere between $46,000 and $60,000 (depending on whether one’s source was the Players Union or the WNBA league itself). The minimum salary of a (male) rookie professional NBA basketball player in 2005–06 was $398,762 (WNBA rookies earned only slightly more than $30,000 that year). The average NBA salary in 2005–06 was $4,037,899. Why was there such a large discrepancy?
  9. The Case in Point on professional sports suggests that most professional athletes now receive salaries equal to their marginal revenue products. These are typically quite high. Are such high salaries fair? Why or why not?
  10. The Case in Point on the airline industry suggested that unions can enhance airline profitability and productivity. How is this possible?
  11. Large retail firms often advertise that their “buying power” allows them to obtain goods at lower prices and hence offer lower prices to their consumers. Explain the economic logic of this claim.

Numerical Problems

Suppose a firm faces the following supply schedule for labor by unskilled workers:

Wage per day Number of workers
$0 0
8 1
16 2
24 3
32 4
40 5
48 6
56 7
64 8
72 9
80 10
  1. In terms of its supply of labor, what sort of firm is this? Explain. Add columns for total factor cost and marginal factor cost and fill them in.
  2. Plot the supply and marginal factor cost curves for this firm. Remember to plot marginal values at the midpoints of the intervals.
  3. Suppose the firm faces the following total product schedule for labor:
Number of workers Output per day
0 0
1 92
2 176
3 252
4 320
5 380
6 432
7 476
8 512
9 540
10 560

Compute the schedules for the firm’s marginal product and marginal revenue product curves, assuming the price of the good the firm produces is $1 and that the firm operates in a perfectly competitive product market.

  1. Add the marginal revenue product curve from Problem 3 to your graph in Problem 2, and determine the number of workers the firm will employ and the wage it will pay.
  2. Now suppose the firm is required to pay a minimum wage of $48 per day. Show what will happen to the quantity of labor the firm will hire and the wage it will pay.
  3. Suppose that the market for cranberries is perfectly competitive and that the price is $4 per pound. Suppose that an increase in demand for cranberries raises the price to $6 per pound in a matter of a few weeks.

    1. Illustrate the increase in demand in the market and in the case of a typical firm in the short run.
    2. Illustrate what happens in the long run in this industry. Assuming that the cost per unit of production remains unchanged throughout, what will the new price be?
    3. Now suppose that the industry is permitted to organize all firms into a producers’ cooperative that maximizes profits. Starting with the solution that you had in (b), illustrate the impact of this change on industry price and output.
  4. Again, consider the market for cranberries. The industry is perfectly competitive and the price of cranberries is $4 per pound. Suppose a reduction in the cost of obtaining water reduces the variable and average total cost by $1 per pound at all output levels.

    1. Illustrate graphically the impact of the change in the short run. Will the price fall by $1? Why or why not?
    2. Now show the impact of the $1 reduction in cost in the long run. Who benefits from the reduction in cost?
    3. Assume again that the producers in the industry are permitted to band together in a cooperative that maximizes profits. Now show the short run impact of the cost reduction on the price and output of cranberries.
    4. Now show the long run impact of the change. Who benefits from the reduction in cost?
    5. Compare your responses to parts (b) and (d), and explain the difference, if any.
  5. A single firm is the sole purchaser of labor in its market. It faces a supply curve given by q = (1/4)w + 1,000, where q is hours of work supplied per day, and w is the hourly wage.

    1. Draw a graph of the firm’s supply curve.
    2. Show the firm’s marginal factor cost curve on the same graph you used in (a).

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