If the minimum wage didn’t effect unemployment, how could we explain that? Monospony in labour markets

de Pony Sum
May 13 · 4 min read

[UNFINISHED DRAFT]

[TECHNICALLY WRONG IN PARTS BECAUSE I TRIED TO OVERSIMPLIFY IT]

I. If the minimum wage didn’t effect employment, how could we explain that?

Recently there has been a great deal of interest among non-economists about various studies which seem to suggest that minimum wage increases do not have a negative effect- or at any rate, a large negative effect- on employment. This reflects a change within economics itself finally trickling out into the wider world- whereas previously it was seen as settled science that minimum wages lower unemployment, the issue is now subject to lively debate.

I’m not a historian of economics but the standard story, which I have no reason to doubt, goes as follows. In 1993 Card & Krueger published a study that appeared to show an increase in the New Jersey minimum wage did not have a negative effect on employment in fast food stores. There followed a series of studies including visually powerful funnel plot analyses that appeared to suggest there was a publication bias in studies towards those that showed an effect.

Unfortunately I don’t know whether or not the minimum wage, at ‘reasonable’ levels, effects unemployment. What I want to explain here is how, if it turns out the minimum wage didn’t effect unemployment- or even lowered unemployment- this could be explained theoretically.

There are a lot of people who take something like the following position. “There are excellent theoretical reasons to believe that the minimum wage causes unemployment, but the empirical case suggests otherwise. This is a paradox.” Actually there is a fairly simple model to explain how the minimum wage might either not effect employment(1). The monopsony model of the labour market.

II. Monopsony in action

Imagine Halloween Town. Halloween village is populated by ghouls, ghasts, ghosts, vampires, skeletons, zombies, wights, spectres, liches, mummies, revenants, draugur and a single witch who loves bread, has the appetite of a thousand strong men, and is also very rich.

Most of the town are self-employed farmers growing grain. Because they are all undead and the witch is the only living person, only the witch needs to eat bread, and so the witch is the only purchaser of the grain. This is the inverse of a Monoply. Instead of there being only one producer of a good, there is only one person who will buy it. We call this a Monopsony, meaning a market in which there is only one buyer.

Now suppose the witch wants to buy 1000 kg of grain a day. The witch will naturally offer the lowest price per kilo of grain that she can to ensure that people are willing to sell her that much grain. The employment situation in Halloween town is pretty dire, so people don’t need to be offered much- 50 cents per kilo is sufficient. The witch is rich enough to pay more, but naturally isn’t going to in the absence of some compelling reason.

Now let’s suppose the mayor mummy Menkaure the fourth sets a regulation- henceforth the minimum price for grain is 1$. Will the supply of grain fall? No, because the Witch’s demand for grain is inelastic- she has plenty of money and needs her thousand kilos of grain a week. Will the number of people farming to provide her with grain fall? No. Will the amount they are paid rise? Yes. We’ve framed it in terms of independent sellers rather than employees to make it slightly easier to follow, but the logic is much the same if the witch owns a farm and must farm a thousand kilos of grain a week, and the mummy mayor changes the minimum wage.

Has a situation like this ever existed in real life? Yes, absolutely, especially in company towns with a single employer.

But outside these special cases this doesn’t sound very realistic does it? Even small towns usually have many employers, and the handful that don’t are surely an exception rather than the rule. However, you don’t need a perfect monopsony for the logic of this situation to apply.

III. Monopsony power without true monopsony.

In a market that is not strictly speaking a monoply, it is possible for the firms involved to nonetheless possess a degree of market power which inflates the prices they can charge.

Let’s look at an example of monopolistic competition that is analogous to the labour market. Suppose that you are walking around the city and want to buy a coffee. There is a coffee shop near you that charges outrageous prices. There is another, cheaper coffee shop with coffee of equal quality- but it’s a two mile walk. Grumbling, you go to the more expensive and closer shop. The coffee shop has exercised its monopoly power to charge higher prices than it otherwise could.

Just as there can exist monopoly competition between sellers, so there can exist monopsony competition between buyers. Instead of a two mile walk, the employee looking to change jobs faces:

  1. Uncertainty about what the new workplace is going to be like. “Better the devil you know”.
  2. An exhausting and demoralising process of job searching.
  3. A black mark on their resume, since sticking with one employer for a longer time generally looks better than swapping around.
  4. In the US, difficulties associated with changing health insurance.
  5. Quite possibly having to move.

If all these difficulties give employers monopsony power- and this certainly seems plausible- we would expect employers to pay less than they would in a competitive market. Force them to pay more, and just like the witch of Halloween town the net advantage they gain from each worker will fall, but they will still gain a net advantage, and thus there will be no reduction in employment.

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(1) There’s an elaboration on this model that will show how under certain conditions increasing the minimum wage can actually increase unemployment, but I’m going to omit it here to keep things simple.

de Pony Sum

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