The Firm: Owners, Managers and Employees
what is the working age population?
a statistical convention, whcih in many countries is all people aged between 15 and 64 years
what is wage labour?
a system in which workers are paid for the time they work for their employers
what is a trade union?
an organisation consisting predominantly of employees, whose principal activities include those such as negotiation of pay and working conditions for all its members
who is a shareholder?
an owner of shares in a company
what is the labour discipline model with a trade union?
as the trade union is now picking the wage, the employer will now have to try and get the maximum effort he can from the employees, given the wage that the trade union picks - this will occur at a point that lies on the best response curve, and so the employer will pick the isoprofit curve that crosses through that point; however, compared to the isoprofit curve that the employer would have picked if there was no trade union, the employer is now forced onto a flatter isoprofit curve - this means that the ratio e/w is now lower, such that the employer is getting less effort per $ compared to the old scenario
why do all isoprofit curves slope upwards?
bceause a higher level of effort wage must be accompanied by a higher wage in order for the effort/wage ratio to stay the same
what are the payoffs for the employer and employee?
employer: profit earned from the output employee: employment rent
how is one's employment rent calculated according to the rectangular graph?
employment rent per hour = wage - disutility of effort per hour - the reservation wage from being unemployed
how is one's total employment rent calculated according to the rectangular graph?
employment rent per hour x expected lost hours of work
what are operating expenses?
expenditures that a business incurs to engage in any activities not directly associated with the production of goods or services e.g. accounting expenditure, legal fees, depreciation, advertising costs etc.
why is there a positive correlation between the hourly wage and effort per hour?
higher wages lead to higher economic rent and thus a higher cost of job loss, which ultimately serves as increased incentive for said employee to work harder - however, the worker's best response to wage curve becomes flatter as the wage increases due to the fact that as the level of effort approaches the maximum possible level, the disutility of effort becomes greater: therefore, it takes larger and larger employment rents (and hence a higher wage) to get an extra given amount of effort from the employee - this shows that an employer paying higher and higher wages will face deminishing marginal returns, such that, the higher the initial wage, the smaller the increase in effort from the employee, and thus the smaller the increase in output that the employer gets from a $1 per hour increase in the hourly wage
how does the best response curve depend on the level of unemployment and the unemployment benefit?
if a worker's duration of potential unemployment increased, assuming that the amount of unemployment benefits received remains fixed, the unemployment benefits per hour (or per week) would be lower as it would be getting stretched out - as a result, their reservation wage would be lower, and the total amount of employment rents lost would be larger as they will be unemployed longer - this would cause the best response curve to shift left; conversely, if unemployment benefits increased, the best response curve would shift right - the further the curve is to the left, the more effort the worker is willing to put in
what is the labour discipline model in a situation where the employer and the trade union have built up a good relationship?
if the trade union feels like the employer has been very reasonable with them in wage negotiations and implemented nice working conditions, the workers may find that their disutility of effort has now decreased, such that they are willing to put in more effort at any given wage - this would result in the worker's best response curve pivoting upwards, and the employer picking a point along an isocost curve that satisfied the wage that the union wants - therefore the new isocost line isn't as flat and the ratio e/w is much better, meaning the employer isn't harmed as much
what would change the employee's best response curve's shape?
improved working conditions: e.g. free breakfast, flexible working hours etc. may convince an employee to work harder for their employer, as said employer has now become more valuable to them - the economic rent from this employer would have risen due to the increased value the worker feels they are getting: as a result, if an employer thinks that the advantage of setting such policies will offset the cost of them, they will adopt them, resulting in the worker's best response curve pivoting upwards - such that the worker will put in more effort at any given wage (other than their reservation wage); if, however, the employee feels that the employer's wages are unfair (e.g. the wage they are being offered is below the market rate of other firms), the worker will likely be willing to put in less effort at any given wage - except the reservation wage - thus causing the worker's best response curve to pivot downwards
what are interest expenses?
interest payable on any type of borrowing e.g. payments due for bonds, loans, lines of credit etc.
what does it mean to be economically inactive?
people who are neither employed nor unemployed, and so are not part of the labour force e.g. people looking after the home, people in education, long-term disabled or sick, retired people, discouraged workers etc.
what are firm-specific assets?
something that a person owns or can do that is of more value to them in their current firm than in their next best alternative e.g. skills, networks and friendships that are specific to the firm a person works for (if someone loses their job as a result of a firm closing down, it is quite possible that they will lose a lot of firm-specific assets which were previously quite valuable - for a consumer, however, if a firm they used to buy products from closed down, they can simply go shop at another similar firm with no concern of having lost any real assets)
what is the slope of the best response curve to wages from the perspective of the employer?
the MRT of paying higher and higher wages into getting more effort from the worker
what is disutility?
the adverse or harmful effects associated with a particular activity or process, especially when carried out over a long period of time
what is the worker's best response function?
the amount of work that a worker will perform for each wage that an employer might offer
what is unemployment?
a situation in which a person who is willing and able to work is not employed
how would a decrease in the supply of labour or an increase in the demand for labour likely affect the models?
1. decrease the number of unemployed, and so likely decrease the unemployment rate 2. the decrease in the unemployment rate would likely mean that the length of expected unemployment (should someone lose their job) would be lower 3. this would increase the reservation wage, thus putting an upward pressure on wage
what can be learnt from the owner-employee game / labour discipline model?
1. equilibrium - the final equilibrium is a Nash equilibrium as each of the players are doing the best response they can, given the actions of the other 2. rent - the employee puts in effort because they receive an employment rent that they may lose if they are to slack off on the job 3. power - as the employee fears losing the rent, the employer is able to exert power over them, getting them to act in ways they otherwise wouldn't if it weren't for the cost of job loss: this contributes to the profits of the employer 4. involuntary employment - if employment rent is received, getting fired leaves the worker worse off: this is only true if the employee could not get reemployed immediately at the same wage - we would also have to assume that there were other potential (unemployed) workers available, such that if said employee was fired, the employer could replace them: as a result if said employee were to lose their job, they would therefore be involuntarily unemployed as they would want a job but be unable to get one (we can come to the same conclusion assuming there is no involuntary unemployment: this would mean that the duration of unemployment was zero, such that if the employee was fired they could instantly get another job at the same wage - therefore their reservation wage is equal to their current wage, further meaning employment rents would be zero meaning that no work is done and no output is produced - employers would now have no reason to employ anyone, and so would have a situation where nobody is employed and everybody is unemployed, contradicting the intial statement that there is no involuntary unemployment)
how would an increase in the supply of labour or a decrease in the demand for labour likely affect the models?
1. increase the number of unemployed, and so likely increase the unemployment rate 2. the increase in the unemployment rate would likely mean that the length of expected unemployment (should someone lose their job) would be higher 3. this would reduce the reservation wage, thus putting a downward pressure on wage
what three important pillars fo a firm's profits depend on?
1. input costs - cost of acquiring the inputs necessary for the production process 2. output - how much output these inputs produce 3. sales - the amount of recenue received from selling goods or services
what are 4 potential aspects of the cost of job loss?
1. lost income - this is the income that is lost while searching for a new job e.g. while you are at home, earning nothing, on unemployment benefits, doing some form of lower-paying self-employment etc. 2. loss of firm-specific assets - this includes things such as the psychological costs of losing workplace friends, and also possibly needing to relocate to another area where jobs are easier to get 3. loss of medical insurance - this can occur in countries like the USA where medical insurance is available through employers 3. social stigma of being unemployed
what are the determinants of the worker's best response curve?
1. the importance to the employee of things that can be bought with the wage 2. how unpleasant it is to exert effort 3. the probability of getting fired when working at each effort level 4. the worker's reservation wage
if a trade union gets involved, and has a very high bargaining power, how would the owner-employer situation change?
1. the union sets the wage 2. the employer informs workers that insufficient work will result in job termination 3. employees resopnd to the wage and the prospect of termination by performing some effort level
what are the 3 reasons as to why employment contracts tend to be incomplete contracts?
1. when a firm writes a contract for the employment of a worker, they cannot know exactly what they will need the employee to do (this will be determined by unforeseen future events) 2. it would be too impractical and costly to observe exactly how much effort each employee puts into the job 3. even if they knew how much effort a worker put in, it is difficult to enforce this (legally)
what is a contract?
a legal document or understanding that specifies a set of actions that the parties to the contract are to undertake
what is net income / profit?
[gross profit - operating expenses - interest expenses] OR [total revenue - total business expenses] (this is known as the firm's bottom line)
what is an incomplete contract?
a contract that does not specify, in an enforceable way, every aspect of the exchange that affects the interest of the parties to the exchange (or others) e.g. an employment contract
what is a sale contract?
a contract that transfers ownership of a product, sold in the market, from the seller to the buyer
what is wage labour contract?
a contract whereby an employee gives the employer the right to direct their activities over certain periods of time in exchange for money
what is the wage curve?
a curve showing the real wage in an economy, as a whole, that has to be paid at a given level of employment (or employment rate) in order to secure adequate worker effort
what is the isoprofit curve?
a curve whose points all yield the same profit per unit of output (it can be considered to be a special type of indifference curve)
what is a worker-owned cooperative firm?
a firm owned mostly by its workers, who have the power to hire and fire the managers e.g. at John Lewis every employee is a partner, and employee councils elect five out of the seven members on the company board (in cooperatives, the workers are the owners of the capital goods and other assets of the company) - cooperatives often need fewer supervisors and managers as it is thought that fellow worker owners will not tolerate other lazy workers, as said lazy workers will be reducing the profit of the firm: this dynamic is thought to lead to higher productivity; additionally, this model is thought to reduce inequality in wages and salaries within the company between, for example, managers and production workers - worker owned cooperatives also tend not to lay off workers when the economy goes into recession, as they instead just cut back on the hours of all the workers, rather than terminating the employment of some
who are the board of directors (B of D)?
a group of people who are elected by a company's shareholders to meet periodically to oversee the company's management and represent the interests of the shareholders (shareholders have the authority to remove / replace members of the board, although, in large companies where there are many shareholders, they rarely exercise this power as it is difficult for them to get together and make decisions: if there is one shareholder with a large stake in a company, however, then they can potentially lead a shareholder revolt)
why are workers willing to put in more effort at a higher unemployment rate?
a higher unemployment rate tends to mean a longer unemployment period, and thus a lower reservation wage - therefore, the profit maximising wage for firms is lower
what is the separation of ownership and control?
the attribute of some firms by which managers are a separate group from the owners, such that they manage the use of other people's funds (the problem with this is that it can lead to conflicting interest between managers and owners - one way of sorting this out is to structure contracts so that managerial compensation depends on the performance of the company's share price, and to ensure that the B of D monitors the performance of managers, such that they also have power to dismiss managers)
what is COGS (cost of goods sold)?
the direct costs attributable to the production of goods sold by a company e.g. direct materials, direct labour, factory overhead, production supplies etc.
what is employment rent / cost of job loss?
the economic rent a worker receives when the value to them of having a job exceeds the value of their next best alternative (the ability of the owner(s) of the firm to terminate employment, serves as a mechanism to motivate employees to put a good amount of effort in, for if they do not, they will lose their economic rent and likely be subject to the dole - however, employment rent does not necessarily have to be measured purely in terms of money)
why can isoprofit curves merely be a specific type of an indifference curve, assuming that the employer is only concerned about profits?
the employer is indifferent between any of the points on the curve as all points on one curve have the same effort-wage ratio - this further tells us the slope of the isoprofit curve is the MRS of wages for effort levels
assuming the employer is a profit maximiser, what combination of wage and effort would the employer choose (insider the feasible set - either on the curve or inside it)?
the employer will want to get the highest amount of effort from the worker for the lowest possible wage - this requires the employer getting the ratio of effort and the wage as high as possible, such that e/w is as high as it can be - this is so that for a given level of the other influences on profits (e.g. revenues from sales, how much output each unit of effort produces, and other costs), the employer can get the cost of effort (i.e. the wage) as low as possible: this is similar to how an employer would have gotten the cost of raw materials as low as possible by using the cheapest supplier - it is just that with a given worker, employers need to be smarter
where would an employer set wages to maximise profits using the worker's best response curve and isoprofit curves?
the employer would pick the point where MRS = MRT, of profit maximisation, when the isoprofit line is that with maximum feasible profits and a point on the worker's best response curve also lies on this line - the wages set at this point are often called efficiency wages
why does the wage curve shift to the left when unemployment benefits increase?
the higher unemployment benefit has essentially raised everyone's reservation wage, and thus their wage expectations (i.e. they need a higher wage in order to get the same economic rent) - therefore the worker's best response curve shifts to the right due to the higher reservation wage, thus causing a given firm's profit maximising wage to increase, as workers willingness to put in effort at a given wage rate has fallen
where is the labour force line on the wage curve diagram?
the labour froce is vertical at a value of the employment rate less than 1, due to the fact that the leftover space (between the labour force and 1) represents economically inactive workers - the unemployment rate is simply the gap between the current employment rate and the size of the labour force
what is the demand for labour?
the number of jobs that employers are seeking to fill
what is the supply of labour?
the number of people seeking work at the going wages and working conditions
what is the labour force?
the number of people who are either employed or unemployed
what is the firm's decision making structure?
the owners, through their board of directors, direct the manager(s) to implement decisions about long term strategies of the firm - the manager then assigns workers to the tasks required for these decisions to be implemented, and attempts to ensure that said the assignments will be carried out
what are the two important aspects of one's job to evaluate when studying one's employment situation ?
the pay that one gets (what they value) and how hard they work (they don't want to do more work than necessary)
who is the residual claimant?
the person who receives the net income from a firm (or other project) after the payment of all contractual costs (e.g. wages) e.g. the owner(s) [the important implication of this, is that a job well done by a manager or an employee - that causes the firm's revenue to increase - will beenfit the owners, but unless it results in a promotion, bonus or salary increase, it will not beenfit the economic actor (the manager or employee) - the only time in which this wouldn't be the case is if it is a small business where the owner is doing virtually everything
what is the unemployment rate?
the proportion of the labour force that are unemployed
what is the employment rate?
the proportion of working age people that are employed
what is the point at which the worker's best response curve crosses the x-axis?
the reservation wage (this is due to the fact that 0 effort will surely result in the worker getting fired, and so the only reason a worker would ever be willing to have a 100% guarantee of getting is when their next best alternative [e.g. unemployment] is paying the same amount, hence this point must be their reservation wage - this also explains why the employee's reservation wage is the absolute lowerst wage that the firm could offer: although they would never actually offer this wage as it is of no benefit to them ebcause the worker is putting in 0 effort)
what is the division of labour?
the specialisation of producers to carry out different tasks in the production process; a process whereby the production process is broken down into a series of stages, and workers are designated to particular stages
why will there never be full employment in the wage curve model?
the wage curve is shaped in such a way that employers would have to pay astronomical wages to meet everyone's wage quota, which would actually put them out of business
when unemployment is higher, why does the worker have less bargaining power?
their reservation wage is lower, meaning that the employer can offer a lower wage that provides the employee with the same level of economic rent - the best response curve shifts to the right when unemployment decreases, however, as the worker has more bargining power and so needs a higher wage in order to achieve the same economic rent
what can be inferred from a steeper isoprofit curve?
this curve has a higher e/w ratio and therefore is more profitable (per unit): in order for the employer to maximise profits, they will seek to go on the highest isoprofit curve
why is the wage curve upward sloping?
this is due to the fact that the higher the wage, the more people whose wage quota will be satisfied - as wages get higher, more and more people's wage expectations are met, thus leading to an upwards sloping wage curve
what is gross profit?
total revenue - cost of goods sold
what is reservation wage?
what an employee would get in alternative employment, or from unemployment benefits or other support, if they were not employed in their current job
what are efficiency wages?
when an employer sets the wage higher than an employee's reservation wage, so as to motivate the employee to provide more effort on the job than they would otherwise choose to make
what are the x and y-axis labels on a wage curve?
x-axis: employment rate y-axis: real wage ('at employment rate X, the wage Y is the result of both employers and employees doing the best they can in respectively setting wages and responding to the wage with a given amount of effort [i.e. Nash equilibrium')
what are the x and y-axis labels on isoprofit curves depicting the employer's objectives?
x-axis: hourly wage ($) y-axis: effort per hour
what are the x and y-axis labels on the best response to wage curve?
x-axis: hourly wage ($) y-axis: effort per hour