Imagine you’re a nurse in a small rural town. There’s exactly one hospital in the area—and if you want to work as a nurse, that’s your only real option. Because there’s no other hospital down the street vying for your expertise, your employer doesn’t have to offer you top dollar. You can see how one firm, sitting at the center of a local labor market, can keep wages down. Economists call this “monopsony power”: when there’s only one (or a few) employer(s) competing for workers, those workers have less power to demand higher wages or better working conditions.
For decades, the textbook model of a perfectly competitive labor market told us that your wage should equal your productivity. The logic was simple: if you produce 20 dollars’ worth of value in an hour, then your boss has to pay you 20 dollars an hour—otherwise, someone else will hire you away and pay you what you’re truly worth. But in the real world, the search for a new job can be time-consuming, commuting distances can be long, and many workers have access to only a handful of local employers (or in some cases just one). Suddenly, that tidy economic story falls apart. This blog post – based on our recent review of the literature – explores how monopsony power limits worker pay, why it arises, and what policymakers can do about it.
Why Monopsony Power Exists
1. Limited Number of Employers
In a perfectly competitive market, there would be a near-infinite number of companies clamoring to hire you. But in reality, there might be just two or three in your area—sometimes only one, as in a company town. Think of monopsony as the labor-market analog to a monopoly in product markets: if just a few employers dominate, they have less incentive to raise wages. If you’re a warehouse worker in a city served mostly by one big distribution center, how many choices do you really have?
When there is a limited number of employers in the labor market, the few employers in the market have monopsony power: they reduce wages below the competitive level because they know all other employers in the market are doing the same, and workers have limited opportunities outside the market.
2. Job Differentiation (a.k.a. The Whole Package)
Even if you do have other employers nearby, not all jobs are created equal. Each position carries a set of features—commute length, coworker relationships, shift schedules, workplace culture—that make it unique. You might be able to switch to a slightly better-paying job, but maybe it requires a much longer commute or less flexible hours. That tradeoff often keeps people in their current jobs, even if the wage falls short of their productivity.
In other words, when jobs are differentiated, it’s not so easy to find the perfect new position. You’re not just shopping for a wage; you’re shopping for an entire package of working conditions. This is how differences across jobs give employers extra leverage to set wages below your true productivity.
3. Search Frictions (the Hassle Factor)
If you’ve ever looked for a job, you know it’s rarely quick or easy. You research openings, polish your resumé, interview—and you may or may not get an offer. When that process is stressful, uncertain, and time-consuming, you’re more likely to settle for less for pay below your real value.
Economists call these barriers “search frictions,” and they create wiggle room for employers to suppress pay. These search frictions prevent you from negotiating simultaneously with multiple employers thereby reducing competition among employers. If you won’t leave for a 1- or 2-dollar raise because you fear the unknown—or just don’t have hours to spend job-hunting—your employer can keep you at a lower wage. That’s monopsony power in action.
What Can Policymakers Do About It?
What can policymakers do to increase wages by reducing employer monopsony power? They can directly address the root cause of monopsony power, for example, by preventing mergers that would decrease the number of competing employers. Or, instead of addressing root causes, they can design policies that mitigate the negative effects of monopsony power. Since monopsony power tends to depress wages and other working conditions, policies that increase wages or improve working conditions can address the effects of monopsony power. For example, minimum wages and unionization can help boost workers’ wages.
1. Antitrust Enforcement
Stopping Harmful Mergers
Antitrust policy is one tool that can reduce employer monopsony power. When two firms merge, the merger reduces the number of employers that compete for a worker’s services. As we just explained, theory predicts that a decrease in the number of employers reduces wages. And economics studies confirm that mergers that greatly reduce the effective number of employers do in fact decrease wages (see studies here and here). Therefore, by preventing mergers, antitrust policy can reduce employer monopsony power. That’s why, in their 2023 Horizontal Merger Guidelines, the U.S. Department of Justice and the Federal Trade Commission emphasized looking at labor-market impacts of mergers, clarifying that they will block mergers likely to significantly lessen competition in labor markets.
Regulating Noncompetes and Other Mobility-Reducing Practices
Another way antitrust policy can decrease monopsony power is by reducing the prevalence of practices that reduce competition for workers, such as non-competition agreements. A non-competition agreement is usually a provision in a contract between an employer and a worker that prevents the worker from accepting a job from the employer’s competitors. Such an agreement clearly reduces the number of potential employers a worker can work for, and makes workers’ job search more difficult. Empirical studies have found that non-competition agreements tend to reduce wages and workers’ mobility. Based on this evidence, the FTC issued a rule banning the use of non-competition agreements in most cases, but the rule was struck down by the courts. Going forward, it remains critical to limit the use of noncompetes, in order to give employees a fighting chance to leverage their productivity for better pay.
2. Minimum Wages
Economists have often criticized the minimum wage as a policy with unintended consequences: by increasing the cost of labor, the government will reduce employers’ willingness to hire people, and so employment will decline. But in a market with substantial monopsony power, the story changes. Because your productivity outstrips what you’re being paid, there’s room for wages to go up without a big hit to employment. With a moderate minimum wage increase, employers are still willing to hire as workers’ productivity is higher than the minimum wage, and employment can even increase as more workers are drawn to these higher-paying jobs.
3. Improving Working Conditions
Wages aren’t everything. Health and safety also matter—and if you have few job options, your employer might let those standards slide. That’s where organizations like the Occupational Safety and Health Administration (OSHA) come in. OSHA inspections ensure a baseline level of safety. These inspections increase health and safety, and do not reduce employment or cause firms to shut down.
Think of OSHA like a “minimum wage for working conditions”: it sets a floor on health and safety. When employers can’t degrade workplace conditions, they can’t exploit their monopsony power to make you accept dangerous or subpar environments.
4. Unions as a Counterweight
Unionization has historically been a critical tool for boosting worker power—especially in markets where employers hold the cards. Through collective bargaining, unions can demand better wages and benefits countering the wage-depressing effects of monopsony power. The empirical evidence shows that the negative impact of employers’ monopsony power on wages is blunted in the presence of unions. Unions are more likely to form in labor markets with high employer monopsony power, and unions disproportionately help increase wages in these markets.
A real-world illustration: consider a manufacturing town dominated by a single large factory. If the workforce is unionized, they’re not individually going hat-in-hand to the employer—they’re negotiating collectively. That collective voice can raise wages closer to true productivity levels, despite all the local constraints on competition.
Pulling It All Together
None of this means the labor market is completely hopeless for workers. Instead, it confirms that textbook “perfect competition” isn’t the norm—and that we need the right mix of policy tools to balance the scales. Here’s the big picture:
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Limited Employer Competition: Real labor markets often have only a few big employers competing for workers. That scarcity of choice depresses wages.
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Unique Jobs: A workplace is more than its paycheck—commute times, supervisor style, and perks all matter. If switching jobs means sacrificing something you value, employers gain leverage to pay you less.
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Search Frictions: Looking for a new job can be time-consuming and uncertain, encouraging workers to settle for less than their true value.
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Policy Solutions: Antitrust laws, minimum wage policies, improved working conditions, and stronger unions can help offset employer market power.
We explore these ideas—and the growing evidence behind them—in our review of the economics literature on monopsony power and policy. The bottom line? Whether you’re a rural nurse, a warehouse worker, or a teacher in a district with few neighboring schools, understanding how limited competition holds wages back shines a light on why pay so often fails to match productivity.
By fostering labor market competition, raising wage floors, and ensuring decent working conditions, policymakers can help close the gap between what workers produce and what they get paid. And when we make it easier for people to switch jobs or collectively bargain, we can build a future in which workers reap the value of what they bring to their jobs—ultimately benefiting both individual livelihoods and the community.
