OxfordAQA International AS and A-level Economics: Wage determination (9640)

This guide is for the OxfordAQA International AS and A-level Economics (9640) specification, version 1.2, sections 3.3.4.3 (wage determination in perfectly competitive labour markets) and 3.3.4.4 (imperfectly competitive labour markets). Section 3.3 is extra International A2 content, assessed in Unit 3 together with the quantitative skills in 3.5. All figures below are invented and illustrative.

Demand and supply curves for labour are taught in the demand for and supply of labour study guide. Here you use them. Related pages: the revision notes, the practice questions, the OxfordAQA A-level Economics hub, the checklist and the free 10-minute diagnostics.

What you need to be able to do

Section	Outcome
3.3.4.3	Explain wage determination in a perfectly competitive labour market, and the role of market forces in setting relative wage rates
3.3.4.3	Appreciate that every real-world labour market falls short of perfect competition, some by more than others
3.3.4.4	Show how monopsony power, unions and poor information make a labour market imperfect
3.3.4.4	Determine wages and employment under a monopsonist (diagram expected)
3.3.4.4	Explain what affects a trade union’s ability to influence wages and employment
3.3.4.4	Analyse a union entering a competitive market and a monopsony market

1. A perfectly competitive labour market

Assume many employers, many identical workers, full information, free movement between jobs and no union. Then:

• The market wage is where market demand for labour meets market supply.
• Each firm is a wage taker. A single firm can hire as many workers as it likes at the going wage, so its supply curve is horizontal there and its average and marginal cost of labour both equal that wage.
• The firm hires up to the point where marginal revenue product (MRP) equals the wage. Each extra worker adds at least as much revenue as cost until that point.

Worked example 1: one firm. A toy workshop sells each toy for 4 cu. Output rises by 24, 20, 16, 12, 8 and 4 toys a day as workers 1 to 6 join.

Worker	MPP (toys)	MRP = MPP × 4 (cu)
1	24	96
2	20	80
3	16	64
4	12	48
5	8	32
6	4	16

At a daily wage of 60 cu, workers 1 to 3 earn the firm at least 60 (the third gives 64), but worker 4 gives only 48. The firm hires 3. If the market wage falls to 40 cu, worker 4 now pays for the cost (48 ≥ 40) and worker 5 does not (32 < 40): it hires 4. The MRP curve is the firm’s labour demand curve.

Worked example 2: the whole market. Region R has a market for parcel sorters (illustrative). W is the wage in cu per hour and Q is the number of workers.

Demand: Qd = 1200 − 40W. Supply: Qs = 200 + 60W. Equilibrium: 1200 − 40W = 200 + 60W, so 1000 = 100W, so W = 10, Q = 800 (check: 1200 − 400 = 800 and 200 + 600 = 800).

Diagram in words: put the wage up the side and the number of workers along the bottom. A downward-sloping demand curve and an upward-sloping supply curve cross at the equilibrium point (800 workers, 10 cu). Above 10 cu there is excess supply, so wages are bid down. Below 10 cu there is excess demand, so employers compete wages up. No one needs to plan the outcome.

Relative wage rates and market forces

Relative wages are one occupation’s pay compared with another’s. Market forces set them and then change them.

1. Suppose demand for sorters rises to Qd = 1400 − 40W, with supply unchanged. Then 1400 − 40W = 200 + 60W, so W = 12, Q = 920. Wages rise 20% and employment 15%.
2. The wage index for sorters is 120 (base 100 at 10 cu) while a comparison occupation stays at 100. Sorters earn 1.2 times as much. That is a signal.
3. Over time, workers retrain and move in. Suppose supply becomes Qs = 320 + 60W. Then 1400 − 40W = 320 + 60W, so W = 10.8, Q = 968. The relative wage has fallen from 1.20 to 1.08 and employment has risen again.

So wage differentials reward scarce skills and pull labour towards where it is most valued. The pull is strong only when workers can move. Differences persist where training takes years, licences restrict entry or people cannot relocate.

Evaluation. The model is a benchmark. It predicts that wages equal MRP, that there are no unemployed workers at the equilibrium wage and that pay differences are temporary. The specification says plainly that all real-world labour markets are imperfectly competitive to some degree, so use the model to ask which assumption fails.

2. Sources of imperfection

Monopsony power. A monopsony has a single buyer of labour. In practice, think of a dominant employer in an isolated town, or a few employers able to act alike. Power is greater when:

• workers’ skills are specific to one employer or industry
• workers are geographically or occupationally immobile, or face high moving costs
• there are few alternative jobs, or employers tacitly agree not to bid up pay

Imperfect information. Workers may not know the wages on offer elsewhere. Searching costs time and money. Employers cannot observe productivity before hiring, so they may rely on signals such as qualifications. The result is that similar workers can be paid differently and wages do not adjust quickly.

Trade unions. A union sells the labour of its members collectively. It makes the supply side a single seller, which is an imperfection in its own right.

3. Wages and employment under a monopsonist

The key point is that a monopsonist faces an upward-sloping supply curve. To hire more, it must raise the wage, and (unless it can pay each worker a different wage) it must pay that higher wage to all existing workers too. The supply curve is the average cost of labour (ACL), and the marginal cost of labour (MCL) sits above it.

Worked example 3. A lone cannery is the only employer in a coastal town (illustrative). L is hundreds of workers, W is cu per hour.

Supply (ACL): W = 4 + L. Demand (MRP): MRP = 40 − 2L.

L	W = 4 + L	Total cost = L × W	MCL (extra cost)	MRP = 40 − 2L
7	11	77	17	26
8	12	96	19	24
9	13	117	21	22
10	14	140	23	20
11	15	165	25	18

The 9th hundred adds 21 to cost and 22 to revenue, so it is worth hiring. The 10th adds 23 to cost and 20 to revenue, so it is not. The monopsonist hires L = 9 where MCL = MRP. Using the formula, MCL = 4 + 2L, so 40 − 2L = 4 + 2L gives L = 9 (the table gives the cost of each whole step, which matches the formula at the midpoint of the step).

The wage is read from the supply curve at L = 9: W = 13, not the MCL. The MRP at 9 is 22, so each worker is paid 9 cu less than the revenue the last one produces. The wage is 13/22 = 59% of MRP.

Competitive benchmark. Setting MRP = supply: 40 − 2L = 4 + L gives L = 12 and W = 16.

	Employment (hundreds)	Wage (cu)
Competitive market	12	16
Monopsony	9	13
Change	−3 (−25%)	−3 (−18.75%)

Diagram in words. Draw a rising supply curve (ACL) and a steeper rising MCL curve above it, both starting at the same point on the wage axis. Draw the downward-sloping MRP curve. MCL cuts MRP at employment 9. Drop down to the quantity axis, then go up to the supply curve to find the wage, 13. The gap between MRP (22) and the wage (13) above that quantity is the monopsonistic exploitation.

Evaluation. Both wages and jobs are lower than in the competitive market, and output is lost, so it is allocatively inefficient. But the result depends on the employer’s power: the more alternative jobs there are, the flatter the supply curve and the smaller the gap. The employer may also pass lower costs on in lower prices if its product market is competitive.

4. Trade unions

What affects union strength

Factor	Stronger union when…
Membership (density)	A high proportion of the workforce belongs, so strike threats are credible
Elasticity of demand for labour	Demand is inelastic, so a higher wage costs few jobs (labour is a small share of costs, or substitutes are poor)
Employer’s ability to pay	Firm is profitable or has market power in its product market
Labour market conditions	Unemployment is low, so members are hard to replace
Skills	Members are scarce and hard to train quickly
Law and politics	Collective bargaining and strike rights are protected
Substitutes	Employers cannot easily replace workers with machines, imports or offshoring

A union enters a competitive market

Using Example 2 (W = 10, Q = 800), suppose the union negotiates 13 cu.

• Employers want Qd = 1200 − 520 = 680 workers.
• Workers wanting jobs: Qs = 200 + 780 = 980.
• Excess supply = 980 − 680 = 300, who are unemployed or queueing.
• Employment falls 15% while the wage rises 30%, so elasticity of demand for labour over this range is −15/30 = −0.5 (inelastic).
• Wage bill: 800 × 10 = 8,000 before and 680 × 13 = 8,840 after, up 10.5%.

Members in work gain, 120 workers lose jobs and 180 more would like them. Because demand here is inelastic, the total paid to labour rises. With elastic demand it would fall. The union also faces a choice between higher wages and more jobs.

A union enters a monopsony market

Using Example 3 (monopsony: L = 9, W = 13), suppose the union sets a minimum wage. Employment is the smaller of the number of workers willing to work at that wage (supply) and the number the firm wants (demand, MRP = wage).

Union wage	Supply at that wage	Demand at that wage	Employment
13 (no union)			9
16	12	12	12
20	16	10	10
22	18	9	9
24	20	8	8

Up to 16 cu the union raises both pay and jobs. Between 16 and 22 pay rises further, and employment falls back but stays above 9. Above 22 (the MRP at the monopsony level of employment), employment falls below the monopsony level. So the result is not a clear trade-off: within a range, a union can raise wages and employment together, because it takes back some of the monopsony gap. Where a union with real bargaining power meets a monopsony, this is bilateral monopoly, and the outcome between 13 and 22 depends on bargaining strength.

Real wages

Unions bargain for nominal pay, but what matters is real pay. If a deal gives 6% and the prices climb by 4% (index 100 to 104), real wages change by 1.06 ÷ 1.04 − 1 = +1.9%.

Evaluation. Unions may also raise productivity through lower turnover and better training. Against that, higher wages can create cost-push pressure, widen the gap between insiders and unemployed outsiders, and encourage firms to switch to capital.

Common errors

• Reading the monopsony wage off the MCL curve. It comes from the supply curve.
• Saying a union always reduces employment. In a monopsony it may raise it.
• Forgetting excess supply when a wage is fixed above equilibrium.
• Treating imperfect information and immobility as the same thing.
• Sketching or describing a diagram but leaving curves, axes or equilibrium points unlabelled.

Official syllabus

OxfordAQA International AS and A-level Economics (9640) specification, version 1.2, first teaching September 2020, first International A-level exams May/June 2022, published by OxfordAQA. Sections 3.3.4.3 and 3.3.4.4, with section 3.5 (quantitative skills).