Unit 6 - The Firm: Owners, Managers, and Employees Flashcards
(44 cards)
1
Q
The division of labour is coordinated in two major ways
A
- Firms
–> the components of goods are produced by different people in different departments of a firm - Markets
–> components produced by groups of workers in different firms are brought together through market interactions + by buying and selling goods on markets, the product gets from the producer to the consumer
2
Q
outsourcing
A
Outsourcing is a business practice in which a company hires a third party to perform tasks, handle operations or provide services for the company.
3
Q
Firms coodination of power
A
- concentration of economic power
- Economic power is in the hands of the owners and managers - they issue directives with the expectation that their employees will carry them out
4
Q
Markets coordination of power
A
- decentralised form of economic power
- Purchases and sales result from the buyers and sellers autonomous decisions
- Price mechanism and market pressures
5
Q
Asymmetric flow of information
A
Owners and managers do not always know what their subordinated know or do, not all of their directions or commands are necessarily carried out
6
Q
Features of the firm
A
- a miniature, privately owned, centrally planned economy
- The distinguishing feature of firms is the suppression of the price mechanism - it works with orders and commands
- labour wage contracts
7
Q
contracts
A
- A contract is a legal document or understanding that specifies a set of actions that the parties to the contract are to undertake
- Contracts for goods sold in markets transfer ownership of the good from the seller to the buyer.
- Contracts for labour grant authority to direct the activities of the firm’s employee from the employee to the manager or owner.
8
Q
similarities and differences of firms and markets
A
- type of contracts: labour wage (temporarily) or goods (permanently) contract
- firm specific assets –> working in a firm means accumulating firm-specific assets that will be lost if the connection to the firm is severed. Relationships with buyers/networking
- social interactions: in firms sometimes extend over decades, or even a lifetime and in markets contacts are typically short lived and not repeated.
- Power: Working in a firm, unlike buying or selling products in a market, means engaging in a relationship in which some individuals have the power to issue orders to others, with the expectation that those orders will be carried out.
9
Q
residual claimants
A
The residual claimant receives the remainder of the sum after all costs have been accounted for.
10
Q
separation of ownership and control
A
- The firms profits legally belong to the people who own the firms assets
- The owners take whatever remains after revenues are used to pay employees, managers, suppliers, creditors and taxes
- Profit is the residual, it is what is left of the revenues after these payments
- The owners claim to it makes them residual claimants
–> this can lead to a conflict of interest since the owners profit from the managers hard work etc.
11
Q
owners are shareholders
A
- By issuing shares to the public as well, the company can raise capital finance
- The use of others people funds leads to the separation of ownership and control
–> leads to principal agent problems
12
Q
principal agent problem
A
- differing interests/objectives of managers and shareholders
- free riding problems
13
Q
A firms profit depends on
A
- Costs of acquiring the inputs necessary for the production process
- Output
- Sales revenues received from selling goods or services
–> firms seek to minimize the cost of acquiring the necessary labour to produce the goods and services they sell
14
Q
problems when hiring
A
A firms cannot write an enforceable employment contract that specifies the exact tasks employees have to perform in order to get paid
15
Q
employment contract
A
omits things that both the employees and the business owners care about: how hard and well the employee will work, and for how long the workers will stay
16
Q
contractual incompleteness
A
- It may be costly for the firm if the employee leaves, but employees retain the right to do so.
- Since the firm does not know all the tasks it will require of an employee, the contract is necessarily incomplete.
- Since effort or the quality of an individual’s work cannot be perfectly monitored and measured, it cannot be specified in the contract.
17
Q
piece rate
A
paying employees based on how productive they are - this method incentivizes employees to put in effort
18
Q
Limitations of piece rate salaries
A
- It’s very difficult to measure the amount of output an employee is producin in modern knowledge and service-based economies
- Employees rarely work alone, so measuring the contribution of individual workers is difficult
19
Q
Employment rent
A
the difference between the value of the job (taking into account all the benefits and costs it entails) and the value of the next best option (being unemployed and having to search for a new job)
20
Q
benefits of employment rent
A
- The employee is more likely to stay with the firm: If she were to quit the job, the firm would need to pay to recruit and train someone else.
- They can threaten to fire the worker: Owners and managers exert power over employees because the employee has something to lose. The threat can be implicit or explicit, but it will make the worker perform in ways that she would not choose unless this was the case.
–> The main reason owners hold power over managers is that they can fire them, and so eliminate their managerial employment rents
21
Q
Counting the cost of job loss
A
- Economic rent - the value of a situation (current job) compared to the alternative if the current situation were no longer possible
- Employment rent (the net cost of job loss) - weigh up all the benefits and costs of working compared with being unemployed and searching for another job
- Costs of working
–> The disutility of work - spending time working on things that one would prefer not to do
–> The cost of traveling to work every day
- Benefits of working
–>Wage income - can be offset by an unemployment benefit or self-employment work
–>Firm-specific assets - such as workplace friends
–>Medical insurance - or other fringe benefits
–>The social status of being employed
22
Q
determinants of employment rent
A
- The pay - something valuable
- How hard she works
23
Q
utility
A
Maria’s utility is increased by the goods and services she can buy with her wage, but reduced by the unpleasantness of going to work and working hard all day—the disutility of work.
24
Q
disutility of work
A
Disutility of work depends on how much effort she puts into her job
25
Formula of net utility per hour
Net utility per hour = wage - disutility of effort per hour
26
Formula for total employment rent
Total employment rent = employment rent per hour x expected lost hours of work (time in which one is unemployed)
27
Reservation wage
the lowest wage that would induce her to accept a job in which she did not experience any disutility of work (for example receiving an unemployment benefit
The wage at which one is willing to forgo unemployment benefits for a job - is indifferent between being unemployed or employed - a change in the disutility of effort would have no effect
28
Formula for the reservation wage
Reservation wage = unemployment benefit - disutility of unemployment
29
Formula for employment rent per hour
Employment rent per hour = wage - reservation wage - disutility of effort + disutility of unemployment
30
labor discipline model
- When the employment rent is large - workers will be willing to work harder in order to reduce the likelihood of losing the job
--> firms influence the employment rent (the cost of job loss) by raising wages
31
the employers best reponse curve
- Increasing wage will increase the likelihood of the employee keeping their job, and the employment rent
- The employee needs to find the balance between this and the effort they put into the job
- A higher wage increases the employment rent and hence the benefit from effort, so it will lead her to choose a higher level of effort
32
best response curve
the effort chosen by the employee for each level of wage (like the production functions, it shows how one variable - here, effort - depends on another - here, wage)
1. Diminishing marginal returns - at higher levels of wages, increases in wages have a smaller effect on effort
2. The slope of the best response curve - the employer’s MRT of higher wages into more worker effort
3. As the level of effort approach the max - the disutility of effort increases - it takes a larger employment rent (and therefore a higher wage) to get effort from the employee
4. The fact that the best response curve slopes upward means that employers face a trade-off
33
to maximise profits
To maximise profits, the employer should find a feasible combination of effort and wage that minimises the cost per unit of effort
--> isocost line for effort
34
to minimise costs
- the employer will seek to reach the steepest isocost line for effort, where the cost of a unit of effort is lowest
- But because the employer cannot dictate the effort, they must pick some point on the employee’s best response curve
35
the isocost line for effort
- the ratio of effort to wages
- The line slopes upward because a higher effort level must be accompanied by a higher wage for the e/w ratio to remain unchanged
- Cost of effort - wage/effort
- The slope of the isocost line for effort - the MRS - the rate at which the employer is willing to increase wages to get higher effort
36
efficiency wage equilibrium of a worker and a firm
- The employer minimises costs and maximises profit at the point where his MRS equals MRT
- Here the employer also balances the trade-off between wages and effort against the trade-off of profit
37
efficiency wages
- employer recognises that what matters is the efficiency units per dollar of wage costs, rather than how much an hour of work costs
- What matters for profits is effort/wage
38
labour discipline model
A model that explains how employers set wages so that employees receive an economic rent (called employment rent), which provides workers an incentive to work hard in order to avoid job termination.
39
What has the labour discipline model told us?
Equilibrium - In the owner-employee game, the employer offers a wage and Maria provides a level of effort in response. Their strategies are a Nash equilibrium.
Rent - In this allocation Maria provides effort because she receives an employment rent that she might lose if she were to slack off on the job.
Power - Because Maria fears losing this economic rent, the employer is able to exercise power over her, getting her to act in ways that she would not do without this threat of job loss. This contributes to the profits of the employer.
40
involuntary unemployment
- Not having a job, although you would be willing to work at the wage that other workers like you are receiving
- In equilibrium, both wages and involuntary unemployment have to be high enough to ensure that there is enough employment rent for workers to put in effort
41
when will the best response curve shift?
- 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
42
a worker-owned cooperative
- 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
- Every employee is a partner, amd employee councils elect five out of seven members of the company board
- Hierarchically organised but the directives issued from the top of the hierarchy come from people who owe their jobs to the worker-owners
- Inequalities in wages and salaries within the company, for example between managers and production workers, are also typically less in worker-owned cooperatives than in conventional firms
43
several reasons for the absence of a complete contract
Information is not verifiable: For a contract to be enforceable, relevant information must be observable by both parties, but also verifiable by third parties such as courts of law.
Time and uncertainty: A contract is generally executed over a period of time, for example specifying that Party A does X now and Party B does Y later.
Measurement: Many services and goods are inherently difficult to measure or describe precisely enough to be written into a contract.
Absence of a judiciary: For some transactions there are no judicial institutions (courts or other relevant third parties) capable of enforcing contracts. Many international transactions are of this type.
Preferences: Even where the nature of the goods or services to be exchanged would permit a more complete contract, a less complete contract might be preferred.
44
hidden action problem
