Whichever market structure is involved, average factor cost is calculated as the total factor cost divided by the quantity of the factor purchased, as illustrated by this equation:

average factor cost

=

total factor cost factor quantity

total factor cost

=

average factor cost

x

factor quantity

Monopsony is a market structure with a single buyer, or in terms of factor markets, a single employer. This means that monopsony is a price maker, with control over the buying side of the market. Market control means monopsony faces a positively-sloped supply curve. To buy a larger quantity, it must pay a higher price.

Average Factor Cost, Monopsony

The table to the right summarizes the average factor cost received by a hypothetical firm, OmniKing Island Resort. This firm is the only employer of labor on a small tropical island. As the only employer on the island, OmniKing is a monopsony with extensive market control, and it faces a positively-sloped supply curve. To employ more workers, OmniKing must pay a higher price.

The first column in the table is the quantity of workers hired, ranging from 0 to 10 workers. The second column is the price OmniKing pays for hiring workers, which increases from a low of $5 for 0 workers to a high of $15 for 10 workers. The third column is the total factor cost OmniKing incurs for hiring various numbers of workers. If OmniKing hires only one worker, then it pays only $6. If it hires five workers, it pays $50. In each case, total factor cost in column three is calculated as the quantity in the first column multiplied by the price in the second column.

The fourth column then presents the average factor cost incurred by OmniKing at each level of employment. These numbers are found by dividing total factor cost in the third column by factor quantity in the first column. For example, the total factor cost of hiring five workers is $50, resulting in an average factor cost of $10 per worker.

The two key observations about average factor cost are:

• First, average factor cost is not constant, but increases as the level of employment increases.


• Second, average factor cost is equal to price at every level of employment. Once again, average factor cost and price are basically two terms for the same concept.

Average Factor Cost Curve, Monopsony

The vertical axis measures average factor cost and the horizontal axis measures the quantity of input (workers). Although quantity on this particular graph stops at 10 workers, it could go higher.

This curve indicates that if OmniKing hires 1 worker (at $6 per worker), then it incurs $6 of average factor cost. Alternatively, if it hires 10 workers (at $15 per worker), then it pays $15 of average factor cost.

This positively-sloped average factor cost curve is actually nothing more than the supply curve facing OmniKing for hiring labor. In the analysis of factor markets, the average factor cost curve and the supply curve facing the firm are almost always one and the same.