THE FIRM AND ITS EMPLOYEES
Full Exam-Ready Explanation Notes
1. Introduction — The Firm–Worker Relationship
A firm must make two main decisions:
• How many workers to hire
• What wage to offer
These decisions are examples of constrained choices, meaning firms must consider limits such as:
• labour costs
• worker productivity
• worker incentives
Strategic Interaction
The relationship between employers and employees is a strategic interaction.
This means:
• Firms decide wages and monitoring policies.
• Workers decide how much effort to supply.
Because each side influences the other, wages and effort are determined through interaction
between firms and workers.
Key Questions of the Unit
This unit studies:
• How firms determine wages
• How wages influence worker effort
• How firms motivate workers
• How employment relationships influence unemployment
2. Structure of the Firm
Most firms operate with a hierarchical structure.
Typical structure:
Board of Directors → Managers → Workers
Board of Directors
The board represents the shareholders (owners).
Responsibilities include:
• monitoring managers
• making strategic decisions
• protecting shareholders’ interests
Managers
Managers are responsible for:
• organising production
• supervising workers
• implementing company strategy
Managers control daily operations of the firm.
, Workers
Workers perform the productive tasks required to produce goods or services.
Their effort level directly affects productivity and profits.
3. Product Contracts vs Labour Contracts
Markets involve different types of contracts.
Product Contracts
Product contracts involve:
• transfer of ownership of goods
• short-term transactions
• one-time exchanges
Example:
Buying groceries at a store.
Once payment is made, the transaction ends.
Labour Contracts
Labour contracts are different because they involve a long-term relationship.
Definition:
Labour Contract = temporary transfer of authority over a worker’s activities to the employer
Characteristics:
• long-term employment relationship
• employer supervises worker activities
• worker effort cannot be perfectly monitored
Because of this, labour contracts are more complex than product contracts.
4. Separation of Ownership and Control
In large firms, owners and managers are often different people.
Owners (Shareholders)
Owners provide capital and legally own the firm.
They receive the firm’s profits.
Profit is defined as:
Profit = Revenue − Costs
Costs include payments to:
• workers
• managers
• suppliers
• taxes
• creditors
Owners are called residual claimants because they receive the remaining income after all costs are
paid.
Full Exam-Ready Explanation Notes
1. Introduction — The Firm–Worker Relationship
A firm must make two main decisions:
• How many workers to hire
• What wage to offer
These decisions are examples of constrained choices, meaning firms must consider limits such as:
• labour costs
• worker productivity
• worker incentives
Strategic Interaction
The relationship between employers and employees is a strategic interaction.
This means:
• Firms decide wages and monitoring policies.
• Workers decide how much effort to supply.
Because each side influences the other, wages and effort are determined through interaction
between firms and workers.
Key Questions of the Unit
This unit studies:
• How firms determine wages
• How wages influence worker effort
• How firms motivate workers
• How employment relationships influence unemployment
2. Structure of the Firm
Most firms operate with a hierarchical structure.
Typical structure:
Board of Directors → Managers → Workers
Board of Directors
The board represents the shareholders (owners).
Responsibilities include:
• monitoring managers
• making strategic decisions
• protecting shareholders’ interests
Managers
Managers are responsible for:
• organising production
• supervising workers
• implementing company strategy
Managers control daily operations of the firm.
, Workers
Workers perform the productive tasks required to produce goods or services.
Their effort level directly affects productivity and profits.
3. Product Contracts vs Labour Contracts
Markets involve different types of contracts.
Product Contracts
Product contracts involve:
• transfer of ownership of goods
• short-term transactions
• one-time exchanges
Example:
Buying groceries at a store.
Once payment is made, the transaction ends.
Labour Contracts
Labour contracts are different because they involve a long-term relationship.
Definition:
Labour Contract = temporary transfer of authority over a worker’s activities to the employer
Characteristics:
• long-term employment relationship
• employer supervises worker activities
• worker effort cannot be perfectly monitored
Because of this, labour contracts are more complex than product contracts.
4. Separation of Ownership and Control
In large firms, owners and managers are often different people.
Owners (Shareholders)
Owners provide capital and legally own the firm.
They receive the firm’s profits.
Profit is defined as:
Profit = Revenue − Costs
Costs include payments to:
• workers
• managers
• suppliers
• taxes
• creditors
Owners are called residual claimants because they receive the remaining income after all costs are
paid.
