How would a monopsony employer hurt labor? A simple dynamic model

A debate has emerged over the growing market power of large firms and its implications for labor markets. Our simplified model shows that monopsony employers hire fewer workers and set wages below the socially optimal level, generating what is called incentive-driven unemployment. Although this structure encourages worker effort, it also compresses wages, producing smaller differentials among workers — both within and across firms — than their productivity differences would warrant. In equilibrium, income inequality is excessive, labor is misallocated, and the job-finding rate is lower than the social optimum. Our numerical examples demonstrate the economic significance of these effects and illustrate realistic labor-market dynamics and plausible micro wage–productivity elasticities.