Monopsony in American Labor Markets
William M. Boal, Drake University and Michael R. Ransom, Brigham Young
University
What is Labor Monopsony?
The term “monopsony,” first used in print by Joan Robinson (1969, p. 215), means
a single buyer in a market. Like a monopolist (a single seller), a monopsonist has power
over price through control of quantity. In particular, a monopolist can push the market
price of a good down by reducing the quantity it purchases. The tradeoff between price
paid and quantity purchased is the supply curve that the monopsonist confronts. A
competitive buyer, by contrast, confronts no such tradeoff — it must accept a price
determined by the market. A monopsonized market will therefore be characterized by a
smaller quantity traded and a lower price than a competitive market with the same
demand and other costs of production.
Monopsony power, like monopoly power, results in economic inefficiency. This is
because the monopsonist avoids purchasing the last few units of a good whose value to
the monopsonist is greater than their marginal cost, in order to hold down the price
paid for prior units. In principle, inefficiency from monopsony can be mitigated by a
well- placed legal price floor, which removes the monopsonist’s power over price and
eliminates its incentive to restrict the quantity it purchases. A modest price floor forces
the monopsonist to take price as given and increase its purchases toward the level of
competitive buyers. However, if the price floor is too high, the monopsonist will reduce
its purchases — just as competitive buyers would do in response to a price floor — and
inefficiency recurs.
In labor markets, “buyers” are employers, “sellers” are individual workers, the “good” is
time and effort, and the “price” is the going wage or salary level. An employer who
enjoys monopsony power holds down the wage by limiting the number of workers it
hires. At the resulting inefficient level of employment, the value of the last worker’s
contribution to output is greater than the wage she or he receives. This gap was termed
the “rate of exploitation” by Pigou (1924, p. 754). It can be shown mathematically that a
monopsonist employer will choose a rate of exploitation (expressed as a percent of the
wage actually paid) equal to the reciprocal of the elasticity of labor supply (the percent
of the workforce lost if wages are cut by one percent). Competitive employers face an
infinite elasticity of labor supply — if they cut wages they lose their entire workforce, at
least in the long run — and consequently are unable to exploit their workers.
Competition thus forces the rate of exploitation to zero. Monopsonist employers by
definition face a finite labor supply elasticity. For example, if a monopsonist faces a
supply elasticity of five, then five percent of the workforce would be lost if wages were
cut one percent, and it can be shown that the monopsonist will choose a rate of
exploitation equal to one-fifth or twenty percent. Inefficiency and “exploitation” from
labor monopsony can be mitigated by a well-placed minimum wage enforced by the
government or perhaps by a labor union. Thus the monopsony model can provide
justification for minimum wage laws and unionism because such measures raise pay,
increase employment, and improve economic efficiency simultaneously!
Elaborations of the Monopsony Model
Cases of isolated labor markets with only one employer are surely rare, so the model
must be elaborated to fit the real world. One elaboration is oligopsony. In oligopsony
models, employers hold power over wages if they are few in number. This power might
derive from collusion if employers cooperate in setting wages. Or it might derive from
inflexibility of their respective workforces. The latter situation, called
the Cournot model, implies that an individual employer that cuts wages cannot lose all
its employees to its rivals, because those rivals cannot absorb additional employees
quickly. Consequently, each individual employer enjoys some power over wages. Both
collusion and the Cournot model imply that the greater the concentration of
employment in a small number of employers, the lower the wage and the higher the
rate of exploitation, holding determinants of labor demand and labor supply constant.
Another elaboration is employer differentiation. If employers differ by location or by
working conditions, workers may not treat them as “perfect substitutes.” An employer
that cuts wages might lose some workers but not all. Thus an individual employer
enjoys power over wages to the extent that its rivals are far away or offer very different
jobs. Recent elaborations of the differentiation concept focus on the process by which
workers are hired. Models of moving costs emphasize that workers, once hired, may
require a substantial wage increase to switch firms. This gives an employer power over
wages for its existing workers, but not for new hires. Models of job searchemphasize
that workers need time to find better jobs. Thus an employer need not match the wages
of other employers. However, to maintain a large workforce, an employer must pay
better-than-average wages to reduce quits. Note that both moving costs models and job
search models imply that workers are more mobile in the long run than in the short
run. As Hicks (1932, p. 83) noted, monopsony power depends inversely on “the ease
with which [workers] can move, and on the extent to which they and their employers
consider the future, or look only to the moment.”
Athletes
A striking example of monopsony in an American labor market is professional baseball.
Until 1976, the “reserve clause” in player contracts bound each player to a single team,
an extreme form of collusion. As a result, teams did not compete for players. Estimates
by Scully (1974) and others indicate that rate of monopsonistic exploitation was very
high during this era — players were paid less than half of the value of their contribution
to output, and possibly as little as one-seventh. After the reserve clause was eliminated
in 1976, players with at least six years’ experience became free to negotiate with other
teams. Salaries subsequently soared. By 1989, the rate of exploitation was estimated to
have fallen close to zero (Zimbalist, 1992).
The early history of baseball, when rival leagues occasionally appeared, yields similar
estimates of monopsony exploitation. Rival leagues undercut the reserve clause, which
could only be enforced among teams in the same league. Thus the appearances of the
American Association in 1882, the American League in 1901, and the Federal League in
1913 each prompted rapid increases in player salaries. But when the rival league was
bought out or merged into the dominant league, salaries always dropped sharply —
usually by about a half (Kahn, 2000). This history suggests that, in the absence of rival
leagues, early professional baseball players were paid no more than half of the value of
their contribution to output.
While no serious rivals to Major League Baseball have appeared since the early
twentieth century, rival leagues have frequently appeared in other professional sports.
For example, the American Basketball Association challenged the National Basketball
Association from 1967 to 1976, the World Hockey Association challenged the National
Hockey League from 1971 to 1979, and the United States Football League challenged
the National Football League from 1982 to 1985. The appearance of each of these rivals
seems to have caused player salaries to increase substantially in their respective sports
(Kahn, 2000).
An even more striking example of monopsony is the market for college athletes. These
players are clearly employees in all but name, but the National Collegiate Athletic
Association strictly limits the amounts that athletes at member colleges and
universities can receive. The value of the output of top college football players has been
estimated at about $500,000 (Brown, 1993), many times more than such athletes are
“paid.”
Teachers and Nurses
For the last few decades, researchers have investigated whether the markets for
American school teachers and nurses are characterized by monopsony. Both
professions may face a limited number of potential employers in any given
geographical region. For teachers, employers are school districts, which are separated
by political boundaries. For nurses, the dominant employers are hospitals, which are
dispersed geographically except in large metropolitan areas. Moreover, teachers and
nurses are (still) predominantly married women, who may find it difficult to move to a
new geographic area if their husbands are employed. Researchers have considered
both oligopsony and differentiation.
Early investigations measured the relationship between employer concentration and
wages. A negative relationship, holding everything else constant, would suggest
oligopsony. Several early studies — for example, Luizer and Thornton (1986) for
teachers and Link and Landon (1976) for nurses — did in fact find negative
relationships. Yet it is unclear whether everything else was held constant in these
studies. Highly concentrated markets with small numbers of employers for teachers or
nurses tend to be rural areas and small cities. Less concentrated markets with many
alternative employers tend to be large cities. But pay for most other occupations —
even less specialized ones with many potential employers — is lower in rural areas and
small cities, so it is not clear that monopsony is to blame. Indeed, studies by Adamache
and Sloan (1982), Boal and Ransom (1999), Hirsch and Schumacher (1995), and others
have shown that employer concentration has little effect on the wages of teachers and
nurses after controlling for city size or the general wage level.
A more recent investigation by Sullivan (1989) focused on differentiation among
employers of nurses. Using data on hospitals, Sullivan estimated that if a hospital cut
wages by one percent, it would lose only about 1.3 percent of its nurses immediately.
This suggests that hospitals enjoy substantial power over wages. However, Sullivan
also showed that a hospital would lose four percent of its nurses within three years and
presumably even more in the long run. Sullivan’s estimates imply that if the hospital
“considers the future,” it is unlikely to lower wages much more than about 10 percent
below the contribution of the marginal nurse to hospital revenue.
Another recent study by Boal (2001) estimated the effects of legal minimum salaries on
employment of teachers in two states. That study found that increases in legal
minimum salaries tended to decrease employment, suggesting that the market for
teachers was more competitive than monopsonistic.
University Professors
Several researchers have suggested that moving costs give a university monopsony
power over its existing workforce because professors face moving costs. This is
because professors have highly specialized skills and their potential employers
(universities) are widely dispersed geographically. Now the market for newly-hired
professors is surely competitive, because new hires must pay moving costs no matter
who hires them. But the market for existing professors is monopsonized because
professors, once hired, may require a substantial wage increase to switch universities.
Moreover, since pay is usually adjusted over time for performance, universities cannot
promise future salary increases at the time of original hire, as school districts do.
Assuming some professors have higher moving costs than others, a modest cut in
wages for existing professors will not cause them all to leave.
The model of moving costs predicts a negative relationship between wages and
seniority (time spent at the same university). Ransom (1993) measured this
relationship, after controlling for total teaching experience, education level, and other
factors influencing professors’ productivity. He did find a negative relationship — the
penalty for senior professors appeared to be roughly 5 to 15 percent. However, formal
models of moving costs imply that newly-hired professors are paid more than the
competitive salary level (in anticipation of later exploitation — see Black and
Loewenstein, 1991) so not all of this penalty is exploitation.
Miners in Company Towns
Textbooks often cite company towns as classic examples of monopsony, especially
towns in the late nineteenth and early twentieth centuries when transportation was
expensive. A company town is a small town located in a remote area with only one
employer. Company towns were most common in mining, where the town’s location
was dictated by mineral deposits. Often the employer owned all the housing and
operated all stores and other services in the town. This arrangement might seem to
give the employer “control” over its workforce and monopsony power through severe
differentiation of employers. However, Fishback (1992) has argued that this
arrangement actually reduced living costs for employees by eliminating market
imperfections in housing and retail markets. High turnover rates in company towns
also cast doubt on the view that workers were “locked in” to their employers (see Boal,
1995).
Company towns were especially widespread in Appalachian coal mining in the early
twentieth century. In West Virginia, for example, 79 percent of coal miners lived in
company-owned housing in the early 1920s. Nevertheless, Boal (1995) showed that
coal mining companies were not very differentiated and enjoyed little power over
wages, at least in the long run. A one-percent cut in wages would cause at least two
percent of the workforce to be lost the same year, and most of it to be lost in the long
run. Thus coal miners seemed to “move with ease.” Assuming employers “considered
the future” with discount rates of no more than 10 percent, they would push wages
down only about 5 percent, according to his estimates.
Early Textile Mill Workers
Several researchers have investigated whether America’s first factories — New
England textile mills — enjoyed monopsony power. Some researchers believe that as
these factories grew in size, they were forced to raise wages in order to attract workers
from farther away, at least in the early nineteenth century (Lebergott, 1960). Other
researchers find no relationship between firm size and wage, but find evidence of
collusion by employers in setting wages (Ware, 1966).
Still other researchers have tried to measure the rate of exploitation by comparing the
value of the last mill worker’s contribution to output with her wage (most mill workers
were women). Implied rates of exploitation range from 9% to over 100% for particular
mills in particular years. However, most estimates of the last mill worker’s contribution
to output are extremely imprecise, so most calculated rates of exploitation are not
significantly different from zero (Vedder, Gallaway, and Klingaman, 1978). Moreover,
the largest estimates are for the middle nineteenth century, not the early nineteenth
century (Zevin, 1975).
Low-wage Workers
All monopsony models suggest that a modest increase in legal minimum wages should
increase employment. In the United States, minimum wages affect only young and
unskilled workers. Most studies of the effects of legal minimum wages in the 1970s and
early 1980s found small decreases in employment for young unskilled workers, as
predicted by the competitive model. However, later studies found almost no effect on
employment (see Wellington, 1991) and a few studies found increases in employment
as predicted by the monopsony model (see Card and Krueger, 1995). However, these
latter studies are controversial (see exchange between Neumark and Wascher, 2000,
and Card and Krueger, 2000) and have not convinced the majority of labor economists
(see Whaples, 1996). In any case, the rate of exploitation, if positive, is probably small.
The Labor Market in General
Search models suggest that all employers enjoy some monopsony power because
workers require time to find better jobs. Formal mathematical models of search, like
those of Burdett and Mortensen (1989), imply monopsony power even in the long run
and predict that larger firms must pay higher wages. This prediction explains the wellknown “firm size-wage effect” — on average, if firm A employs one percent more
workers than firm B, it pays 0.01% to 0.03% higher wages for the same kind of workers
doing the same kind of jobs (Brown and Medoff, 1989, pp. 1304-1305). Assuming the
“firm size-wage effect” is due to monopsony power, firms are pushing wages down by
one to three percent below the value of the contribution of the last worker to output.
On the other hand, search models also predict that most firms and jobs pay high wages
and only a few pay low wages. This prediction does not fit the facts, even controlling for
skill differences across workers. Efforts to fit the model of Burdett and Mortensen
(1989) to actual data have been frustrated by this problem. The best such estimates to
date suggest that on average wages are pushed down 13 to 15 percent due to search
(van den Berg and Ridder, 1993), but these estimates are surely very rough.
Summary
The simple monopsony model provides an alternative explanation to the standard
competitive model of how wages are determined. It predicts that employers will hold
wages down below the value of the last worker’s contribution to output (“exploitation”)
by limiting the number of workers they hire. But it is too simple to fit real American
labor markets, so elaborations such as oligopsony or differentiation of employers are
needed.
Estimates of monopsony exploitation to date in American labor markets have yielded
surprising results (see Table 1 for a rough summary). Monopsony does not appear to
have been important in company mining towns, a standard textbook example, or in
markets for teachers and nurses, early suspects. In fact, the largest plausible estimates
of monopsony exploitation to date are not for blue-collar workers but rather for
professional athletes and possibly college professors.
Table 1 - Estimated Rates of Monopsonistic Exploitation in American Labor Markets
References and Further Reading
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Issues.” Journal of Health Economics 1, no. 1 (1982): 81-108.
van den Berg, Gerard J. and Geert Ridder. “An Empirical Equilibrium Search Model of
the Labour Market.” Vrije Universiteit, Amsterdam, Faculty of Economics and
Econometrics Research Memorandum 1993-39, July 1993.
Black, Dan A. and Mark A. Loewenstein. “Self-Enforcing Labor Contracts with Costly
Mobility: The Subgame Perfect Solution to the Chairman’s Problem.” Research in Labor
Economics 12 (1991): 63-83.
Boal, William M. “The Effect of Minimum Salaries on Employment of Teachers.”
Unpublished paper, Drake University, 2001.
Boal, William M., and Michael R. Ransom. “Missouri Teachers.” Unpublished paper,
Brigham Young University, 2000.
Boal, William M., and Michael R. Ransom. “Monopsony in the Labor Market.” Journal of
Economic Literature 35, no. 1 (1997): 86-112.
Brown, Charles, and James Medoff. “The Employer-Size Wage Effect.” Journal of Political
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Brown, Robert W. “An Estimate of the Rent Generated by a Premium College Football
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Burdett, Kenneth, and Dale T. Mortensen. “Equilibrium Wage Differentials and Firm
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Card, David E., and Alan B. Krueger. Myth and Measurement: The New Economics of the
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