Chapter 6: The firm - Owners, managers and employees Flashcards
Division of labour
The specialisation of producers to carry out different tasks in the production process. Also known as: Specialisation.
Difference between markets and firms
Markets involve a decentralisation of power. Whereas, firms represent a concentration of economic power in the hands of the owners and managers.
Contracts for goods
Contracts for goods sold in markets transfer ownership of the good from the seller to the buyer.
Contracts for labour
Contracts for labour grant authority to direct the activities of the firm’s employee from the employee to the manager or owner.
Firm specific assets
Something that a person owns or can do that is more value in the individual’s current firm than in their next best alternative.
Residual claimant
The person who receives the net income from a firm or other project after the payment of all contractual costs (for example the cost of hiring workers and paying taxes). – Owners
Shareholder
Owning a share means owning a part of the assets of a firm. It gives the shareholder a right to receive a proportion of a firm’s profit and to benefit when the firm’s assets become more valuable. Also known as: Common stock.
Benefit of offering shares in a company
By issuing shares to the general public a company can raise capital to finance its growth, leaving strategic and operational decisions to a relatively small group of specialised managers.
3 things that a firms profit depends upon (before taxes)
- Costs of acquiring the inputs necessary for the production process.
- Output: how much these inputs produce.
- Sales revenues received from selling goods or services.
An employment contract is incomplete because…
- It cannot protect the firm from employees who fail to work hard or well enough
- It cannot stop employees leaving the firm
Why do firms generally not use piece rate to pay employees?
- It is very difficult to measure the amount of output an employee is producing in modern knowledge- and service-based economies (think about an office worker, or someone providing home care for an elderly person).
- Employees rarely work alone, so measuring the contribution of individual workers is difficult (think about a team in a marketing company working on an advertising campaign, or the kitchen staff at a restaurant).
Employment rent
The employment rent is a measure of what we call the cost of job loss. Employees are typically paid much more than the minimum they would accept for taking the job, so they are receiving an economic rent (called an employment rent), meaning that they would prefer to keep the job rather than ending up with the reservation option. Economic rents make loosing a job a meaningful threat.
The cost of a job loss for a worker includes:
- Lost income while searching for a new job (perhaps partially offset by an unemployment insurance benefit or, in poorer countries, by the possibility of lower-paying self-employment or work on the family farm).
- Loss of firm-specific assets such as the psychological costs of losing workplace friends, and possibly needing to relocate with one’s family to some other locality where jobs are easier to get.
- Loss of medical insurance available through an employer in some countries.
- The social stigma of being unemployed, which for most people is equivalent to a substantial financial cost.
How to calculate employment rent
To calculate employment rent you need to know:
- Wage
- What she would get (in monetary terms) if she lost her job, in terms of satisfaction.
Employment rent per hour = wage - disutility of effort per hour
e.g. paid $12 per hour and disutility of $2 = employment rent of $10
Disutility is the satisfaction gained from not working.
Employment rent, taking into account unemployment benefits
Employment rent per hour = Wage - Reservation wage - Disutility of effort
Reservation wage AKA unemployment benefit
Employment rent, taking into account the duration of unemployment
Employment rent = Employment rent per hour X Expected hours of lost work time
