Lecture 6 Topic 6

Question 1

what do firms want to maximise?

Answer 1

profits

Question 2

what choices do firm owners make to maximise profits?

Answer 2

how much to produce
at what price to sell
how much to pay employees

Question 3

what impacts do firm owners choices have?

Answer 3

macro and micro impacts

macro = indirect
micro = direct

Question 4

what is the structure of the lower discipline model?

Answer 4

• employer (principal) is the first mover and announces wage w
• worker responds to w by selecting a level of effort e
• the principal then chooses total hours h to give to employee
• termination probability with probability t(e), contract renewed with probability 1-t(e)
• if terminated, employee receives fallback (0) & the game ends
• if not terminated, the game is repeated

Question 5

does the no shirking game connect micro and macroeconomics?

Answer 5

yes

because macroeconomy affects the fallback option of workers

workers’ fallback option depends on the level of employment in the economy and the unemployment benefit

Question 6

how does the no shirking game work?

Answer 6

employer (first mover) sets a no-shirking level of effort and announces the contract will be terminated if underperformance is detected

workers’ willingness to work is B+u(e) (line underneath u)

this is the minimal price the employer could offer the worker if contract is incomplete

Question 7

the least the employer could pay, leading to the worker being no worse off is…?

Answer 7

w > B + u(e)

wage is larger in expected payoff than employment benefit + low effort

line underneath u

Question 8

why can’t effort be purchased under a complete contract?

Answer 8

because workers may be able to exert minimal effort and still get paid, so employers must incentivise workers by providing a high enough wage w to get desired effort e

Question 9

what is the minimal wage to incentive workers called?

Answer 9

no shirking wage

Question 10

what are the steps of the no shirking game?

Answer 10

• employer announces no shirking level of effort and termination probability t
• the worker decides to povide e (no shirking level of effort) or e=0 (doesn’t work)
• if the worker provides e (doesn’t shirk), they’ll receive w, wont be terminated and experience disutility u(e)
• if the worker provides e<e (shirks), they may be detected and terminated (t) or undetected and paid w (1-t)
• if terminated, they’ll find another job with probability 1-j or remain jobless with probability j
• if they remain jobless, they’ll receive B (unemployment benefit)
• if they get a new job, they’ll get w-u (same as if they didn’t shirk)

Question 11

what does the employer need to consider to find the no shirking wage?

Answer 11

• the workers payoff if they don’t shirk: wage - disutility of effort w-u
• the workers payoff if they do shirk: depends on the probability they get fired (t), if fired, the probability they remain jobless and their unemployment benefit if they remain jobless

Question 12

to motivate workers to have desired level of effort employers must…

Answer 12

offer wage with higher expected payoff than if they shirked

e=e > e=0

no shirking level of effort payoff > shirking level of effort payoff

Question 13

ICC = ?

Answer 13

w-u > (1-t)w + t(1-j)(w-u) + tjB

• w-u = payoff for not shirking
• 1-t(w) = not terminated
• t(1-j)(w-u) = terminated, immediately finds another job
• tjB = terminated, remains jobless with unemployment benefit

Question 14

national accounts = ?

Answer 14

system used to measure overall output and expenditure in a country

Question 14

what are the 3 equivalent ways to measure GDP?

Answer 14

• total spending on domestic products
• total domestic production
• total domestic income

Question 14

components of GDP = ?

Answer 14

• consumption (c) = expenditure on consumer goods & services
• investment (i) = expenditure on newly produced capital goods
• gov. spending (g) = gov. expenditure on goods & services
• net exports (trade balance) = exports (x) minus imports (m)

Question 15

equation for GDP considering all components?

Answer 15

GDP = C + I + G + X - M

gross domestic product = consumption + investment + gov. spending + exports - imports

Question 16

in most countries ____ makes up majority of their GDP

Answer 16

private consumption

Question 17

business cycle = ?

Answer 17

alternating periods of positive & negative growth rates

Question 18

recession = ?

Answer 18

period when output is declining or below its potential level

Question 19

what does the business cycle affect?

Answer 19

market outcomes

Question 20

Okun’s law = ?

Answer 20

a strong & stable relationship between unemployment and GDP growth

Question 21

changes in GDP growth are connected in what way with the unemployment rate?

Answer 21

negatively connected

Question 22

output falls…

Answer 22

unemployment rises …
wellbeing falls

Question 23

% change in GDP = ?

Answer 23

% change in all components added together

(C, I, G, X, M)

Question 24

high demand…

Answer 24

high capacity utilisation…
investment…
even higher demand

Question 25

investment decisions depend on….?

Answer 25

depend on firms’ expectations about future demand

Question 26

describe the cycle linking hiring/investing, spending, demand and profits

Answer 26

• economy’s doing well, so firms increase investment and employment
• lower unemployment leads to higher wages
• higher wages leads to reduced profits
• reduced profits lead to reduced investment & GDP growth
• reduced employment leads to reduced wages
• reduced wages leads to higher profits
• higher profits leads to increased investment & employment

cycle continues…