Imperfections in the Labour Market

In the real world, labour markets are rarely perfectly competitive. This is because workers or firms usually have the power to set and influence wages and therefore wages may be set to levels different than anticipated by MRP theory.

Different Imperfections in the Labour Market

1. Monopsony

This occurs when there is just one buyer of labour in a market.
Even if there are more than one employer, firms may still have the ability to set wages. Therefore they have Monopsony power

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The marginal cost of employing one more worker will be higher than the average cost because to employ one extra worker the firm has to increase the wages of all workers.

To maximise the level of profit the firm employs Q2 of workers where MC = MRP

Therefore the firm only has to pay a wage of W2. This is less than the competitive wage.

2. Trades Unions:

Under certain conditions, Trades unions can bargain for wages above the competitive equilibrium

This can be achieved by restricting the supply of labour (e.g. closed shops) or threatening to go on strike.

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Trades Unions can cause higher wages, however, in competitive markets, this can have the effect of causing unemployment of Q1 – Q2

However, Trades Unions can be beneficial if

  • They operate in an industry with a Monopsonistic employer
  • They help to increased productivity by bringing in new working practices

3. Discrimination

Firms may not be rational but pay some workers different wages on the grounds of age, race, or gender. See: discrimination in labour markets.

4. Difficult to measure productivity

The theory of MRP assumes firms can measure the MPP of a worker however in practice this is difficult because in many jobs, especially in the service sector productivity cannot be measured precisely
e.g. how do we measure the productivity of nurses and teachers?

Therefore wages may be set due to different reasons other than MRP

5. Firms may be Non-Profit Maximisers

If demand for a product falls, MRP theory suggests wages are likely to fall. However, firms may be reluctant to cut wages or make people redundant therefore they may keep paying high wages despite this.

6. Wages will vary due to geographical differences:

In the North, wages tend to be lower because there is less demand and higher unemployment. In the South, wages tend to be higher for the opposite reason.

In theory, workers from the north could move to the south to take advantage of better employment opportunities. However, there are likely to be geographical immobilities – e.g. it is difficult for workers to move)

This is because:

i) They are attached to their local communities
ii) Difficult to find housing in the south
iii) Ignorance of Jobs elsewhere

7. Poor information

Workers or firms may suffer from poor information. E.g. workers may be unaware of better-paid jobs elsewhere. This enables firms to have monopsony power.

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