The firm, owners, managers and emeployees Flashcards
What is a firm?
A business organisation that:
Purchases inputs to produce goods and services
Employs people
Exists to make a profit
Sets prices greater than the cost of production.
How do firms differ from markets?
Contracts
Duration of relationships
What is a contract?
A legal document or understanding that specifies a set of actions that parties to the contract must undertake.
How do firms and markets differ in the contracts that form the basis of exchange?
Contracts for products sold in markets permanently transfer ownership of the good from the seller to the buyer.
Whereas contracts for labour in firms temporarily transfer authority over a person’s activities from the employee to the manger or owner.
How do relationships differ in markets and firms?
Relationships in markets are typically short-term, whereas relationships in firms may extend over long period of time.
What are firm specific assets?
They are valuable only while the worker remains employed in a particular firm.
When the relationship ends, value is lost to both sides.
What is separation of ownership and control?
When managers decide on the use of other people’s funds.
What can be the conflict of interest between owners and managers?
The firm’s profits legally belong to the firm owners, the managers’ actions have impact on profits, but if profits increase thanks to managers’ work, managers will not automatically benefit.
Managers may have other interests besides maximising profits. There is a conflicting of interest between managers and owners.
This is an example of the principle-agent problem.
How do you solve the conflict of interest between managers and owners?
Link the managers’ pay to the performance of the company’s share price.
Monitor the managers’ performance.
How is hiring employees different from buying other goods and services?
The contract between a firm and its employees is incomplete:
Some tasks depend on future events
Some aspects of the job are difficult to measure and base wages on e.g. effort.
What are incomplete contracts?
Do not specify , in an enforceable way, every aspect of the exchange.
How can you overcome incomplete contracts?
Piece rate work.
What is piece rate work?
a type of employment in which the worker is paid a fixed amount for each unit of production.
How does piece rate work overcome incomplete contracts?
It provides motivation for employees to work harder.
If firms can’t directly measure effort, why do workers work hard?
Internal motivators
External motivators
