Unit 6

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THE FIRM: OWNERS, MANAGERS, AND EMPLOYEES.

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Introduction Firms Owners and Managers Employees Labour Discipline Model Principal-agent models.

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A. Introduction.

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The Context for This Unit. Work is an important part of economics. In models of economic interactions, bargaining determines the division of social surplus. All parties gain from these interactions, but have conflicting interests over how these gains (profits) are shared. How are wages determined within firms? What are the economy-wide effects of firm interactions? (Unit 1) (Unit 5).

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This Unit. Analyse how firms differ from markets Use a model of interactions within the firm to explain how wages are determined, and how this influences unemployment Explore the problem of incomplete contracts and hidden actions.

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B. Firms.

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What is a firm?. Firm = a business organization which Employs people Purchases inputs to produce market goods and services Sets prices greater than the cost of production “The firm in a capitalist economy is a miniature, privately owned, centrally planned economy.”.

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Firms vs. markets. 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 Power is decentralized in markets, so decisions are autonomous and voluntary.

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Structure of a firm. Owners decide on long-term strategy Managers implement their decisions by assigning tasks to workers and monitoring them.

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Contracts. Firms and markets differ in the contracts that form the basis of exchange. 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..

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Relationships within a firm. 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 These 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..

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C. Owners and Managers.

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Separation of ownership and control. Managers ≠ owners Separation of ownership and control = when managers decide on the use of other people’s funds..