Dynamic Monopsonistic Competition and Labor Market Equilibrium

With the recent special issue of the Journal of Labor Economics on the topic, the concept of monopsony in the labor market seems to have achieved a new respectability as a formulation of wage setting institutions in labor markets. (See Ashenfelter, Farber, Ransom (2010) for a summary.) However, in the "new monopsony" literature, the market environment is not one in which a single buyer faces a static supply curve as originally formulated by Robinson (1969). Instead, the source of an employer’s market power is search friction, as in Burdett and Mortensen (1998). Specifically, the net flow of workers to the firm is sensitive to an employer’s wage relative to that paid by all other firms because price discovery takes time and firms move from lower to higher paying emploers. In other words, the market is better described as one of dynamic monopsonistic competition. Formally, a dynamic monopsonistically competitive equilibrium is a Nash equilibrium solution to a dynamic price setting game played by many anonymous players in an environment characterized by search friction. Understanding this fact is crucial for policy analysis, such as the study of the effects of a minimum wage, as well as for the study of labor market dynamics. The principal purpose of the paper is to introduce a variant of the BurdettMortensen model which is tractable for both macro economic and policy applications. The environment is one in which each employer has the power