1. THE ECONOMY: THE CORE PROJECT

2. UNIT 6. THE FIRM : OWNERS, MANAGERS AND EMPLOYEES

3. T6.1 Markets and firms
Which of the following statements are correct regarding the difference between markets and firms?
Select all correct answers
Transactions within firms operate as contracts. Market transactions are not contracts.
Working in a firm involves accumulation of firm-specific assets that will be lost if the connection to the firm is severed.
Markets involve a decentralisation of power, while firms represent a concentration of economic power.
It is possible to employ division of labour within firms, while it is not possible in markets.
Section 6.1

4. ANSWER: T6.1 Markets and firms
Which of the following statements are correct regarding the difference between markets and firms?
Select all correct answers
Transactions within firms operate as contracts. Market transactions are not contracts.
Working in a firm involves accumulation of firm-specific assets that will be lost if the connection to the firm is severed.
Markets involve a decentralisation of power, while firms represent a concentration of economic power.
It is possible to employ division of labour within firms, while it is not possible in markets.
Feedback
A sale (a market transaction) is a contract that transfers the ownership of the good from the seller to the buyer.
Firm-specific assets include networks, skills, and relationships, which lose value to both sides when the worker is no longer employed in that firm.
Firms represent a concentration of economic power in the hands of the owners and managers, whereas in free markets, power is not concentrated only in the hands of sellers or buyers.
Division of labour can also be employed in markets, for example, firms can specialise in a particular stage of the production process of a good.
Section 6.1

5. T6.2 The labour discipline model
Which of the following statements best describes the game played by the employer and the employee in the labour discipline model?
Select one answer
The game is a simultaneous game where the employer chooses the wage level and the employee chooses the effort level simultaneously.
The game is a one-off game where the wage and effort levels are determined once and for all.
The worker selects the effort level that balances his desire to keep his job with his desire to not exhaust himself on the job.
The employer will attempt to maximise the firm’s profits by offering a wage equal to the worker’s reservation wage.
Section 6.7

6. ANSWER: T6.2 The labour discipline model
Which of the following statements best describes the game played by the employer and the employee in the labour discipline model?
Select one answer
The game is a simultaneous game where the employer chooses the wage level and the employee chooses the effort level simultaneously.
The game is a one-off game where the wage and effort levels are determined once and for all.
The worker selects the effort level that balances his desire to keep his job with his desire to not exhaust himself on the job.
The employer will attempt to maximise the firm’s profits by offering a wage equal to the worker’s reservation wage.
Feedback
The game is a sequential game where the employer, knowing the employee’s possible decisions, selects the wage level first. The employee then selects his effort level given the offered wage level.
The game is a repeated game where wages and effort levels decisions are made in each period.
In the labour discipline model, putting in effort is costly for the worker, but he earns an employment rent from keeping his job. The amount of effort chosen depends on the relative size of these effects.
d. At reservation wage the worker will have no incentive to exert any effort. Therefore this will not be the firm’s best response strategy.
Section 6.7

7. T6.3 Involuntary unemployment
Which of the following statements is correct regarding involuntary unemployment?
Select one answer
When a firm sacks a worker against her wishes but she can get another job immediately, there is involuntary unemployment.
When there is involuntary unemployment, the employment rent is zero.
When there is no involuntary unemployment, firms must be employing workers without ever dismissing them.
There must be involuntary unemployment in an efficiency wage equilibrium.
Section 6.7

8. ANSWER: T6.3 Involuntary unemployment
Which of the following statements is correct regarding involuntary unemployment?
Select one answer
When a firm sacks a worker against her wishes but she can get another job immediately, there is involuntary unemployment.
When there is involuntary unemployment, the employment rent is zero.
When there is no involuntary unemployment, firms must be employing workers without ever dismissing them.
There must be involuntary unemployment in an efficiency wage equilibrium.
Feedback
If the worker can get another job immediately, then there is no unemployment, involuntary or not.
When there is involuntary unemployment there is a strictly positive cost of unemployment (workers willing but unable to work for the wages that other workers are receiving), so the employment rent is greater than zero.
When there is no involuntary unemployment, the workers’ employment rent is zero so they will put zero effort in. Therefore, firms will not employ anyone.
In an efficiency wage equilibrium, both wages and involuntary unemployment have to be high enough to ensure that there is enough employment rent for workers to put in effort.
Section 6.7

9. T6.4 A rise in unemployment benefits
The figure below depicts the effect of an increase in the unemployment benefit on the workers’ best response curve, when the unemployment rate is 12%. Which of the following statements is correct following a rise in the unemployment benefit?
Select one answer
The firm’s profit level falls.
The workers’ reservation wage falls.
The efficiency wage at any given level of employment falls.
The firm sets a lower efficiency wage.
Section 6.8

10. ANSWER: T6.4 A rise in unemployment benefits
The figure below depicts the effect of an increase in the unemployment benefit on the workers’ best response curve, when the unemployment rate is 12%. Which of the following statements is correct following a rise in the unemployment benefit?
Select one answer
The firm’s profit level falls.
The workers’ reservation wage falls.
The efficiency wage at any given level of employment falls.
The firm sets a lower efficiency wage.
Feedback
Higher unemployment benefits mean that the workers’ reservation wage will be higher
Higher unemployment benefits increase the value of the workers’ reservation option, so their reservation wage will be higher.
The efficiency wage set by the firm rises from WL to WH, and this effect would be the same for all unemployment rates.
The efficiency wage set by the firm rises from WL to WH, as depicted on the diagram.
Section 6.8