Show how monopsony may lead to increased employment after the introduction of a minimum wage.

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An employer under imperfect competition (in a labor market where it has an employment pool largely to itself) may end up paying workers less than their productivity warrants and hire fewer of them than is efficient. Under these conditions, a higher minimum wage geared to the level of the marginal output of the least productive worker could theoretically both increase the wage level and induce a higher level of employment in the firm.

It is true that labor markets are not perfectly competitive because of frictions such as imperfect imperfect information which make them somewhat sticky. Under conditions of strong monopsony (which is not a given), and if the firm's profits are stable over time it could theoretically set its minimum wage level slightly higher to achieve both higher wages and employment. However, most small and many larger businesses experience periods of unprofitability where they must effectively subsidize their employees to retain them until seasonal profitability returns. In this case a higher minimum wage might be unsustainable causing the firm to exit the market and raise unemployment.

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