Week 7_ Unit 6 THE FIRM: OWNERS, MANAGERS, AND EMPLOYEES

Question 1

What is a firm?

Answer 1

way of organizing production with the following
characteristics:

One or more individuals own a set of capital goods that are used in production.

• They pay wages and salaries to employees.
• They direct the employees (through the managers they also employ) in the production of goods and services.
• The goods and services are the property of the owners.
• The owners sell the goods and services on markets with the intention of making a profit.

Question 2

How is division of labour coordinated?

Answer 2

In a capitalist economy, the division of labour is coordinated in
two ways: firms and markets

Coordination within firm differs from coordination via markets:
• Concentration of economic power in the hands of the
owners/managers allows them to issue commands to
workers. “The firm in a capitalist economy is a miniature,
privately owned, centrally planned economy.”
• Power is decentralized in markets, so decisions are
autonomous and voluntary

Question 3

Structure of a firm?

Answer 3

Owners decide on long-term
strategy

Managers implement their decisions by assigning tasks to workers and monitoring them

Question 4

Contract ?.

Answer 4

Contract = a legal document or understanding 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

Question 5

Firms vs. Markets: Relationships?

Answer 5

Unlike in markets, relationships within a firm may extend over a
long period of time.
• creation of network of colleagues
• acquisition of skills necessary for the job

skills, networks, and friendships 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.
In this sense, people making up a firm have a common interest: the
firm’s success

Question 6

How to solve conflict of interest between managers and owners?

Answer 6

• link the managers’ pay to the performance of the
company’s share price
• monitor the managers’ performance

Question 7

Describe conflict of interest between owners and managers?

Answer 7

Mangers must operate at owner’s desire for increased profit, but they do not directly benefit from this. The owner does.

Question 8

Incomplete contracts?

Answer 8

Incomplete contract does not specify, in an enforceable way, every
aspect of the exchange that affects the interests of parties

e.g.
• Some tasks depend on future (unknown) events.
• Some aspects of the job are difficult to measure and base wages
on e.g. effort.

Question 9

Piece rate pay?

Answer 9

Piece rate work = a type of employment in which the worker is
paid a fixed amount for each product made.

Piece rate pay gives workers an incentive to exert effort

Question 10

Then how can employers induce high effort from workers?

Answer 10

Piece rate pay
Workers’ effort (fear of being fired)
Employment Rents