Unit 6: The Firm: Workers, Managers & Employees Flashcards
Why do firms exist?
To coordinate production where markets fail due to incomplete contracts.
What is an incomplete contract?
A contract that cannot specify every detail of a task or future contingency.
What is the principal-agent problem?
The employer cannot fully monitor the effort of the worker.
What is employment rent?
The net benefit a worker gets from being employed versus unemployed.
Why do workers exert effort?
To avoid losing the employment rent associated with their job.
How can firms motivate workers?
By paying above the reservation wage and creating employment rents.
What is the reservation wage?
The minimum wage a worker is willing to accept.
What is the best response curve?
It shows the worker’s effort level in response to different wages.
What is the isocost line of effort?
Combinations of wage and effort that result in the same cost per unit of effort.
What is an efficiency wage?
A wage that maximises effort per unit cost for the firm.
When does a firm choose the efficiency wage?
When the isocost line is tangent to the best response curve.
What shifts the best response curve?
Changes in unemployment benefits, job alternatives, and unemployment duration.
How does unemployment affect employment rent?
Higher unemployment or longer job search increases employment rent.
Why do firms not use performance-based contracts?
Because effort is hard to observe and verify in most jobs.
What gives employers power over workers?
Employment rents that make workers fear job loss.
What gives workers power in the firm?
The ability to withhold effort or quit.
Why are isocost lines flatter at higher effort levels?
Because the cost per unit of effort is lower.
What role does the efficiency wage play in unemployment?
It contributes to equilibrium unemployment as firms pay above the reservation wage.
How do firms balance wages and effort?
By finding the point where they get the most effort for the least cost.
What happens if reservation wages rise?
Firms must pay more to elicit the same effort, shifting the best response curve.
