Unit 6 - The firm: Owners, Managers and Employees Flashcards
What is a firm?
An organisation which:
- Pays wages (w) to employ people (L)
- Purchases inputs (K,M,Hc)
- To produce goods (Q)
- In order to make profit (pi)
What is an incomplete contract?
A contract that cannot enforce everything the firm and workers care about (e.g. attitude, working hours, emergencies)
Why are contracts typically incomplete?
- Managers do not know precisely how workers will contribute
- Worker effort cannot be constantly observed
What is Employment rent? And why is it important
The job pay - fallback option (welfare benefit)
Persuades the worker to take the job and stay in the firm
Threat to fire a low-effort worker is credible
What is a contract?
A legal document that entails the set of actions that parties must undertake
What is a contract for products and contract for labour
Products = transfer ownership of a good from seller to buyer
Labour = temporarily transfer authority over a persons activities from employee to owner or manager
What is revenue from selling products used to pay? And what remains
- Wages for employees and managers (w)
- Suppliers for material input prices (Pm)
- Creditors; capital costs (interest rates r)
- Government taxes (t)
Profit remains –> TR - TC = pi
What is a residual claimant
The person/agents who receives the income left over from a firm or other project after the payment of all contractual costs
Managers may not always work in the owners best interest (e.g. maximise profit) causing conflict of interest. How can this be managed?
- Managerial compensation tied to firm performance (performance-related clause)
- BoD (representing the owners) can fire a manager
How can economy changes affect worker effort and wages in:
Increase in unemployment benefits
Increase in unemployememt
Increase in benefits will mean reservation wage is higher so wage has to increase to provide enough employment rent (also higher cost of effort // isocost line)
Increase in unemployment will mean people more likely to take jobs and will increase effort per hour (lower cost of effort // isocost line)
In what ways is a family different to a firm
Common goals: family all have similar goal whereas firm, workers, managers etc. have different goals
Altruism vs self-interest: firm values individual achievement and reward for work vs a family value bonds and relations built on altruism
Ownership structure: firm is owned by a group with different stakes vs a family has most things held in common
Due to many managers and workers etc. it is difficult for owners to monitor the actions of managers. What could they use to act as an indicator for managerial action
What is the collective action problem
Share prices indicate the performance of the firm and inform directors about how managers are doing.
This is known as the Efficient Markets Hypothesis: prices fully reflect all known information
Collective action problem is the idea that it is easier for managers to organise themselves and undermine the ability of owners to monitor them effectively
What is a business owners maximation problem when dealing with worker effort
Maximize the level of effort for given costs of effort OR Minimize the costs, given the feasible effort
What is the Efficient Markets Hypothesis
The idea that prices fully reflect all known information
What is a firm known as if TR and Profit increase but the remaining contractual costs (wages, input costs, interest rate, taxes) do not
The firm is a stage
