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Since its genesis in industrial organization and the theory of the firm, models of imperfect competition have permeated many fields of economics ranging from international trade to macroeconomics to public finance. For example, in the 1980s, the introduction of product market imperfections revolutionized our understanding of trade policies and comparative advantage (Brander and Spencer, 1985; Krugman, 1979). At the same time, macroeconomists began to use models of monopolistic competition to explain how small costs of adjusting prices could give rise to business fluctuations (Akerlof and Yellen, 1985; Blanchard and Kiyotaki, 1987; Mankiw, 1985). This trend is now influencing labor economics, with a growing literature arguing that employers have some market power in the setting of wages. Indeed, the most common sources for market power-product differentiation and imperfect information-seem to apply with equal if not greater force to labor markets as compared with product markets. The advantage of an approach based on oligopsony is that it leads to more plausible and less elaborate explanations of many labor market phenomena that are otherwise regarded as puzzles. This paper surveys a number of areas where this approach has proved fruitful in recent years.
One point should be clarified at the outset. The question of whether a labor market is "imperfectly competitive" is often equated with the question of whether an employer is a monopsony in the traditional sense-that is, the sole employer in a labor market. Traditional monopsony is clearly unrealistic, since employers obviously compete with one another to some extent. But there are a range of choices between perfect competition and monopsony where a degree of market power coexists with competition between employers. It is best to think in terms of "oligopsony" or "monopsonistic competition" as the most accurate descriptions of the labor market we envisage. Oligopsony describes a situation where employer market power persists despite competition with other employers-the number of employers does not need to be small. Monopsonistic competition is oligopsony with free entry, so that employer profits are driven to zero.
"The Law of One Wage"
We begin with an empirical example that is difficult to explain using a competitive model. One key prediction of perfectly competitive labor markets is the "law of one wage," which holds that there should be a single market...