Unit 6 - The Firm: Owners, Managers, and Employees

Question 1

Relationship-specific assets

Answer 1

• valuable only while the worker remains employed in the firm - when the relationship ends, the value of the assets is lost for both sides
• examples: relationships between collegues, networks

Question 2

Residual claimants

Answer 2

• Profits are residual - the owners are residual claimants

Question 3

The principal-agent problem

Answer 3

• The separation of ownership and control - shareholders have differing objectives/interests than managers
• leads to free-riding opportunities

Question 4

Contractual incompleteness

Answer 4

• An employment contract omits things that both the employees and the business owners care about - i.e the employees’ effort and quality of work

Question 5

Piece rate

Answer 5

• paying employees based on how productive they are

Question 6

Limitations of piece rate payment

Answer 6

• it’s difficult to measure the amount of output produced by an employee in a service based industry
• employees work in teams

Question 7

Employment rent

Answer 7

• the difference between the value of the job and the value of the next best option (being unemployed and searching for another job)
• the net cost of job loss
  employment rent –> wage - disutility of effort

Question 8

Benefits of employment rents

Answer 8

• the employee is more likely to stay with the firm if the employment rent is high
• owners and managers exert power over employees if the employment rent is high (great value of the job compared to the value of not having the job)

Question 9

Disutility of work

Answer 9

• the value of the time spent working, which could have been invested in doing other preferred things
• depends on the effort put into the job

Question 10

Net utility per hour

Answer 10

net utility per hour = wage - disutility of effort per hour
- this is the employment rent per hour

Question 11

Total employment rent

Answer 11

total employment rent = employment rent per hour x expected lost hours of work (time in which one is unemployed)

Question 12

Reservation wage

Answer 12

= the wage at which one is willing to forgo unemployment benefits for a job - is indifferent between being unemployed or employed

reservation wage = unemployment benefit - disutility of unemployment

Question 13

Employment rent per hour

Answer 13

employment rent per hour = wage - reservation wage - disutility of effort + disutility of unemployment

Question 14

The implications of employment rents

Answer 14

• when the employment rent is large - workers will be willing to work hard in order to reduce the likelihood of losing their job (because the value of the job is high or the value of the next best option is low)
• employers can increase employment rents by raising wages

Question 15

Best response curve

Answer 15

• It is the frontier of the feasible set of combinations of wages and effort the firm can get from its employees
• This is determined by the fact that a higher wage increases the employment rent and therefore the benefit from effort - so higher wages will lead employees to choosing a higher level of effort
• slope - MRT

Question 16

Diminishing marginal returns

Answer 16

• At higher levels of wages, increases in wages will have a smaller effect on effort - the curve flattens

Question 17

Isocost line for effort

Answer 17

• Shows the ratio of effort to wages
• the slope - the MRS - the rate at which the employer is willing to increase wages to get higher effort

Question 18

The trade-off between profit maximisation and wages for the employers

Answer 18

To maximise profits, the employer has to find a feasible combination of effort and wage that minimises the cost per unit of effort

Question 19

Efficiency wage equilibrium of a worker and a firm

Answer 19

• At the point where the Isocost with the minimum feasible cost is tangent to the worker’s best response curve
• MRS = MRT

Question 20

Determinants of the worker’s best response curve

Answer 20

• the utility of the things that can be bought with the wage
• the disutility of effort
• the reservation wage
• the probability of getting fired when working at each effort level
• the best response curve will shift if these factors change

Question 21

What are the effects of an increase in the duration of a period of unemployment?

Answer 21

• Reservation wage decreases
• Extends the period of lost work time

Question 22

What would be the effect of a rise in unemployment benefits for the best response curve?

Answer 22

Reservation wage increases - therefore the best response curve will shift to the right

Question 23

Worker-owned cooperative

Answer 23

• the workers are the owners of the capital goods and other assets of the company, and they select the managers who run the company on a day-to-day basis