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

optimal wage

is called the efficiency wage

A firm's profit equals

it's revenue minus it's costs

fear of being fired is related to

the "costs of job loss" - employees fear getting fired when they are *paid more than the value of their next best option*, being unemployed and having to search for. a new job. the difference between current pay and next best option is called *employment rent*.

incomplete contracts

the contract between a firm and its employees is incomplete: - some tasks depend on future (unknown) events - important information, such as the employee's effort, is asymmetric or non-verifiable. incomplete contract does not specify, in an enforceable way, every aspect of the exchange the affects the interests of parties.

employment rent

*also known as: cost of job loss.*

when managers decide on the use of other people's fund's, this is referred to as

*separation of ownership and control*

employment rents can benefit owners and managers in two ways:

*the employee is more likely to stay with the firm* *they can threaten to fire the worker*

Why are employment contracts incomplete?

- The firm cannot contract an employee not to leave. - The firm cannot specify every eventuality in the contract. - The firm is unable to observe exactly how an employee is fulfilling the contract.

The division fo labor is coordinated in two ways in a capitalist economy

- firms -markets

to avoid the following costs of job loss

- lost income while searching for a job - costs required to start a new job e.g. relocation - loss of non-wage benefits - social costs aka stigma of being unemployed

global production networks

- many large firms outsource today

structure of a firm

- owners decide on long-term strategy - managers implement their decisions by assigning tasks coworkers and monitoring them

incomplete contracts in jobs you have held etc,

- was every aspect of your job spelled out? - was there a chance for you to do less than what was expected of you? - was how you did your work completely specified or did you have some autonomy? -what things that the employer would like to see the employee do or not do - cannot be covered in a contract, or if they are, cannot be enforced?

calculate the *growth rate* if a country's income is $2,000 in 2018, and in 2019 it's $2,500.

2,500 - 2,000 / 2000 500/2000 = 0.25 25%

What is a firm?

:a business organization which - employs people - purchases inputs to produce market goods and services -sets prices *greater than the cost of production* -firms are central planners!

Structure of a firm

Board of Directors (owners) I I Manager I I workers

asymmetric information

Since owners or managers do not always know what their subordinates know or do, not all of their directions or commands (grey downward arrows) are necessarily carried out. The dashed upward green arrows represent a problem of asymmetric informationasymmetric information Information that is relevant to the parties in an economic interaction, but is known by some but not by others. See also: adverse selection, moral hazard.close between levels in the firm's hierarchy (owners and managers, managers and workers).

worker effort

Workers can work hard or shirk. Shirkers - fired if caught. if firms can't directly measure effort, why do workers work hard?

Efficiency wage theory suggests that the cost minimizing wage causes

a decrease in the turnover rate

contract

a legal document specifying a set of actions between two entities. contracts for products sold in markets permanently transfer ownership of the good from the seller to the buyer. contracts for labor temporarily transfer authority over a person's activities from the employee to the manager or owner.

piece rate work

a type of employment; worker is paid a fixed amount for each product made. - piece rate pay gives workers an incentive to enter effort rarely used: - difficult to measure modern jobs - employees often work as a part of a team

calculating the employment rate (cost of job loss)

add up all the benefits: - wage income - medical insurance and benefits - social status - firm specific benefit subtract from this all the costs: - disutility of work - cost of traveling to work everyday, work clothes, etc. - costs of child care

Which way does the curve of the labor model shift if unemployment increases?

answer: left a worker feels. greater cost of job loss as his/her state of employment is prolonged

Firms

are a major actor in capitalist economies

A firm is composed of

individuals, whose needs and desires might conflict - we need to understand not just economics but also psychology to understand the firm.

owners

decide on long-term strategy

division of labour

firms and markets

manager

implement their decisions by assigning tasks to workers and monitoring them

outsourcing

obtain (goods or a service) from an outside/foreign supplier, in place of an internal source. example: apple designs in U.S but products are assembled overseas

In a labour contract,

one side of the contract has the power to issue orders to the other side, but this power is absent from a sale contract.

principal-agent problem

principal - employer agent - employee work effort matters to both parties but is not covered in the employment contract .

what is the cost minimizing wage?

wage / quantity of input

efficiency wage

wages set higher than the reservation wages so workers will care about losing the job and provide more effort.

separation of ownership and control

when managers decide on the use of other people's funds.

disutility of work

work / leisure

if firms can't directly measure effort why do workers work so hard?

work ethic feelings of responsibility to reciprocate a feeling or gratitude forged working conditions possibility of promotion *fear of being fired*

When the cost of job loss is large,

workers will be willing to work harder in order to reduce the likelihood of losing their job.