Unit 6: The Firm Flashcards
what is a firm
business organisation which employs people, purchases inputs to produce market goods & services and sets prices greater than the cost of production
in capitalist economy, division of labour is split between firms and markets
how firms differ from markets in terms of coordination
concentration of economic power in the hands of the owners/managers allows them to issue commands to workers
power is decentralised in markets, so decisions are autonomous and voluntary
relationships in a firm may extend over time such as creation of network of colleagues and acquisition of skills necessary for the job
these skills, networks etc are firm-specific aspects
Contracts
legal documents or understandings that specifies a set of actions that parties to the contract must undertake
contracts for products sold in markets permanently transfer ownership of the good from the seller to the buyer
contracts for labour temporarily transfer authority over a person’s activities from the employee to the manager or owner
Conflict of interest within a firm
firm’s profits legally belong to those who own the firm’s assets
managers actions have impact on profits
but if profits increase thanks to managers work they will not automatically benefit
could be solved by linking managers pay to the performance of the company’s share price and monitor managers performance
An employees incomplete contract
contract between firm and employees is incomplete as
some tasks depend on future events
some aspects of the job are difficult to measure and base wages on e.g effort
Piece-rate pay
a type of employment in which the worker is paid a fixed amount for each product made
gives incentive for effort
difficult to measure output in modern jobs
often work as a team
why would workers work hard if firm can’t measure effort?
work ethic
feeling of responsibility to reciprocate good working conditions
benefits for measurable output
promotions
fear of being fired
Employment rent
employees fear getting fired when they are paid more than their reservation option
= cost of job loss which includes:
- lost income while job searching
- costs required to start a new job e.g relocation
- loss of non-wage benefits e.g medical insurance
- social costs (unemployment stigma)
Calculating employment rents
= wage - reservation wage - disutility of effort
reservation wage = value of next best option (other employment or unemployment benefits)
Labour discipline model
if there’s a large employment rent
there’s a large cost of job loss
so worker puts in more effort to reduce chance of getting fired
so firm could raise wages to increase cost of job loss
Graph of effort against wage
Slope = MRT
firms profit is the worker’s output - wage
as there’s a tradeoff between wages and effort, employer should find combination of effort and wage that minimises cost per unit effort
the cost of effort is the same along all points on an isocost line (slope = MRS)
profits maximised when MRS=MRS
Efficiency wage
wages set higher than the reservation wage so workers will care about losing the job and provide more effort
Best response function on wage, effort graph will shift to changes in
- the utility of things the wage can buy
- the disutility of effort for the reservation wage
- the probability of getting fired at each effort level
Cooperative
a firm that is mostly or entirely owned by its workers who hire and fire managers
because profits are paid out to the workers, there is less need for supervision and monitoring
Incomplete contracts arise when
information isn’t verifiable
the relationship covers periods of time
there is uncertainty
there are difficulties with measurement
judiciary is absent
preferences for omitting some information exist
