A monopsony is a market with one buyer or employer. The United States Postal Service, for instance, is the sole employer of mail carriers in this country, just as the armed forces are the only employers of military personnel. Single-employer towns once dotted the American landscape, and some occupations still face monopsony power regularly. Nurses and teachers, for example, often have only a few hospitals or local school districts for which they can work.

Because a monopsonist is the only buyer of some input, it will face a positively sloped supply curve for that input, such as supply curve S_L in Figure APX-2. This firm could hire 14 workers for $10 (point a), or it could increase wages to $11 and hire 15 workers (point b). Because the supply of labor is no longer flat, however, as it was in the competitive market, adding one more worker will cost the firm more than the new worker’s higher wage. But just how much more?

The marginal factor cost (MFC) is the added cost associated with hiring 1 more unit of labor. In Figure APX-2, assume that 14 workers earn $10 an hour (point a), and hiring the 15th worker requires paying $11 an hour (point b). Assume that you decide to go ahead and hire a 15th worker. When you employed 14 workers, total hourly wages were $140 ($10 × 14). But when 15 workers are employed at $11 an hour, all workers must be paid the higher hourly wage, and thus the total wage bill rises to $165 ($11 × 15). The total wage bill has risen by $25 an hour, not just the $11 hourly wage the 15th worker demanded. The marginal factor cost of hiring the 15th worker, in other words, is $25 per hour. This is shown as point c. Because the supply of labor curve is positively sloped, the MFC curve will always lie above the S_L curve.

How does being a monopsonist in the labor market affect the hiring of a firm that is competitive in the product market? The monopsonist shown in Figure APX-3 is a competitor in the product market and has a demand for labor equal to its VMP_L. This firm faces the supply of labor, S_L. It will hire at the level where MFC = VMP_L (point a), thus hiring L₀ workers at wage W₀ (point b). Note that these L₀ workers, although paid W₀, are actually worth W₁. Economists refer to this disparity as the monopsonistic exploitation of labor. Again, the term is loaded, but to economists it describes a situation in which labor is paid less than the value of its marginal product.

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Note that the wages paid in the monopsony situation (W₀) are less than those paid under competitive conditions (W_C), and that monopsony employment (L₀) is similarly lower than competitive hiring (L_C). As was the case with monopoly power, monopsony power leads to results that are less than ideal when compared to competitive markets.

To draw together what we have just discussed, Figure APX-4 portrays a firm with both monopoly and monopsony power. The firm’s equilibrium hiring will occur at the point where MFC = MRP_L (point a), and thus the firm will hire L₀ workers, although at wage W₀. Note that this is the lowest wage and employment level shown in the graph. If the firm only had monopsony power, it would hire L₁ workers (point b) at a wage of W₁, which is higher than W₀. If the firm only had monopoly power, it would also hire L₁ workers for wage W₁ (point c). Both of these employment levels and wage rates are less than the competitive outcome of L_C and W_C (point d).

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The key lesson to remember here is that competitive input (factor) markets are the most efficient, because inputs in these markets are paid precisely the value of their marginal products, and the highest employment results. This translates into the lowest prices for consumers at the highest output, assuming efficient production. Thus, just as competition is good for product markets, so too is it good for labor and other input markets.