Wage employment relationship model

wage employment relationship model

They set wages so that employees experience a cost if they lose their jobs. . in a firm. In Unit 7, we will look at the firm as an actor in its relationship with other firms and with its customers. Work and wages: The labour discipline model. Through its integration of Hicks' IS-LM model with the labour market, Was the relationship between wage rigidity and unemployment the. The Employment and Wage Relationship. by: Brett Judd. Is there a relationship between the number of people employed in Wyoming and how much money they .

To understand the firm, we will model how employers set wages and how employees respond. We have already seen, in earlier units, the importance of work and firms in the economy: Work is how people produce their livelihoods. In deciding how much time to spend working, people face a trade-off between free time and the goods that they can produce or the wage income that they can earn, as we saw in Unit 4.

We also know that there are potential gains for all concerned from individuals specializing in tasks for which they have a comparative advantage through the division of labour.

The division of labour may be coordinated through market exchange, as in the invisible hand game in Unit 2. In Unit 5, the interaction between Angela and Bruno was coordinated by a contract that traded the use of land for a share of the crop.

Labour market: Wage setting relationship

Another way that work may be coordinated and combined with other inputs is by organization within a firm. In this unit, we study how the coordination of labour takes place within firms in the modern capitalist economy. We model how wages are determined when there are conflicts of interest between employers and employees, and look at what this means for the sharing of the mutual gains that arise in a firm.

In Unit 7, we will look at the firm as an actor in its relationship with other firms and with its customers. Producing smartphones involves many distinct tasks, done by different employees within the companies that make components for Apple—Toshiba or Sharp in Japan, or Infineon in Germany.

Setting aside the work done in families, in a capitalist economy, the division of labour is coordinated in two major ways—firms and markets. Among the institutions of modern capitalist economies, the firm rivals the government in importance. John Micklethwait and Adrian Wooldridge explain how this happened. John Micklethwait and Adrian Wooldridge. A Short History of a Revolutionary Idea. Why do firms work the way they do?

For example, why do the owners of the firm hire the workers, rather than the other way around? Randall Kroszner and Louis Putterman summarize this field of economics. Kroszner and Louis Putterman editors. The Economic Nature of the Firm: Through firms, the components of goods are produced by different people in different departments of the firm and assembled to produce a finished shirt or iPhone. Components produced by groups of workers in different firms may also be brought together through market interactions between firms.

By buying and selling goods on markets, the finished iPhone gets from the producer into the pocket of the consumer. In this unit, we study firms. In the units to follow, we study markets. Herbert Simon, an economist, used the view from Mars to explain why it is important to study both. Imagine a visitor approaching Earth from Mars, Simon urged his readers. Looking at Earth through a telescope that revealed social structure, what would our visitor see?

Companies might appear as green fields, he suggested, divisions and departments as faint contours within. Connecting these fields, red lines of buying and selling. Within these fields, blue lines of authority, connecting boss and employee, foreman and assembly worker, mentor and mentee.

Traditionally, economists had focused on the market and the competitive setting of prices. But to a visitor from Mars, Simon suggested: Organizations would be the dominant feature of the landscape. It is composed of individuals, whose needs and desires might conflict. In what ways could these differences be resolved? An employment relation where a boss dictates the task after the sale is the relationship at the heart of a firm.

When the desired task is easy to specify in a contract, Simon explained that we could view this as simply work-for-hire. But high uncertainty the employer not knowing in advance what needs to be done would make it impossible to specify in a contract what the worker was to do and, in this case, the result would be an employer—employee relation that is characteristic of the firm.


Understanding how contract work turns into employment helps us understand a particular relationship between two members of an organization. For Simon, the study of markets needed to be supplemented—even supplanted—by institutions and governments better equipped to handle uncertainty and rapid change.

By the time of his death inSimon had seen many of his ideas reach the mainstream. Behavioural economics has roots in his attempts to build economic theories that reflect empirical data. The coordination of work The way that labour is coordinated within firms is different to coordination through markets: Firms represent a concentration of economic power: This is placed in the hands of the owners and managers, who regularly issue directives with the expectation that their employees will carry them out.

Markets are characterized by a decentralization of power: Although the government can tax and regulate private property, the idea of private property specifically limits the things a government or anyone else can do with your possessions.

These two books describe the property rights, authority structures, and market interactions that characterize the modern capitalist firm. The Ownership of Enterprise. The Economic Institutions of Capitalism. In a firm, by contrast, owners or their managers direct the activities of their employees, who may number in the thousands or even millions. Walmart is an exceptionally large firm, but it is not exceptional in that it brings together a large number of people who work in a way coordinated by the management to make profits.

Like any organization, firms have a decision-making process and ways of imposing their decisions on the people in it. Owners decide long-term strategies The owners, through their board of directors, decide the long-term strategies of the firm concerning how, what, and where to produce.

They then direct the manager s to implement these decisions. Managers assign workers Each manager assigns workers to the tasks required for these decisions to be implemented and attempts to ensure that the assignments are carried out. Flows of information The green arrows represent flows of information.

The upward green arrows are dashed lines because workers often know things that managers do not, and managers often know things that owners do not. Since owners or managers do not always know what their subordinates know or do, not all of their directions or commands grey downward arrows are necessarily carried out. The firm could tempt its customers with a special offer, but unlike the relationship with its employees, it cannot require them to show up. When you buy or sell something, it is generally voluntary.

In buying or selling, you respond to prices, not orders. The firm is different; it is defined by having a decision-making structure in which some people have power over others.

He concluded that conflict between employers and workers was inevitable. Buying and selling goods in an open market is a transaction between equals—nobody is in a position to order anyone else to buy or sell. In the labour market, in which owners of capital are buyers and workers are the sellers, the appearance of freedom and equality was, to Marx, an illusion.

wage employment relationship model

Instead, the wage allowed the employer to rent the worker and to command workers inside the firm. Marx thought that the power wielded by employers over workers was a core defect of capitalism. A Critique of Political Economy. Great economists Karl Marx Adam Smith, writing at the birth of capitalism in the eighteenth century, was to become its most famous advocate.

Karl Marx —who watched capitalism mature in the industrial towns of England, was to become its most famous critic.

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Born in Prussia now part of Germanyhe distinguished himself only by his rebelliousness as a student at a Jesuit high school.

Inhe became a writer and editor for the Rheinische Zeitung, a liberal newspaper, which was later closed by the government. After this, he moved to Paris and met Friedrich Engels, with whom he collaborated in writing The Communist Manifesto Marx then moved to London in At first, Marx and his wife Jenny lived in poverty. He earned money by writing about political events in Europe for the New York Tribune. Marx saw capitalism as just the latest in a succession of economic arrangements in which people have lived since prehistory.

wage employment relationship model

Inequality was not unique to capitalism, he observed—slavery, feudalism, and most other economic systems had shared this feature—but capitalism also generated perpetual change and growth in output. Perpetual change arose, Marx observed, because capitalists could survive only by introducing new technologies and products, finding ways of lowering costs, and by reinvesting their profits into businesses that would perpetually grow.

Marx also had influential views on history, politics, and sociology. He thought that history was decisively shaped by the interactions between scarcity, technological progress, and economic institutions, and that political conflicts arose from conflicts about the distribution of income and the organization of these institutions.

He thought that capitalism, by organizing production and allocation in anonymous markets, created atomized individuals instead of integrated communities. These themes include the firm as an arena of conflict and of the exercise of power this unitthe role of technological progress Unit 1and the problems created by inequality Unit 5.

When economists agree Coase and Marx on the firm and its employees In the nineteenth century, Marx had contrasted the way that buyers and sellers interact on a market, voluntarily engaging in trade, with how the firm is organized as a top—down structure, one in which employers issue orders and workers follow them.

Note the character of the contract into which an [employee] enters that is employed within a firm … for certain remuneration [the employee] agrees to obey the directions of the entrepreneur. In The Nature of the Firm he wrote: If a workman moves from department Y to department X, he does not go because of a change in relative prices but because he is ordered to do so … the distinguishing mark of the firm is the suppression of the price mechanism.

Its top—down decision-making structure resembles the centralized direction of production in entire economies that took place in many Communist countries and in the US and the UK during the Second World War.

Over this, they disagreed. But they also advanced economics with a common idea. How economists learn from data Managers exert power These three investigations, published as books, show the effect of the power that managers and owners exert. In Nickel and Dimed: Life in Low-pay Britain, Polly Toynbee, a British journalist, had previously done the same in the UK intaking jobs such as call centre employee and home care worker.

The difference between market interactions and relationships within firms is clear when we consider the differing kinds of written and unwritten contracts that form the basis of exchange. A sale contract for a car transfers ownership, meaning that the new owner can now use the car and exclude others from its use.

A rental contract on an apartment does not transfer ownership of the apartment which would include the right to sell it ; instead it gives the tenant a limited set of rights over the apartment, including the right to exclude others including the landlord from its use.

Under a wage labour contract, an employee gives the employer the right to direct him or her to be at work at specific times, and to accept the authority of the employer over the use of his or her time while at work.

The employer does not own the employee as a result of this contract. If the employer did, the employee would be called a slave. When sold in markets, they permanently transfer ownership of the good from the seller to the buyer. A contract does not have to be written: It can be an understanding between the employer and the employee. How might the actors and decision-making structure of three organizations, GoogleWikipediaand a family farm compare with this?

Draw an organizational structure chart in the style of Figure 6. A labour contract transfers ownership of the employee from the employee to the employer. According to Herbert Simon, a visitor approaching Earth from Mars with a telescope that reveals social structure would see a network of red lines market exchanges connecting green spots firms and consumers.

In a labour contract, one side of the contract has the power to issue orders to the other side, but this power is absent from a sale contract. A firm is a structure that involves decentralization of power to the employees. That would be slavery. A labour contract grants the firm the authority to direct the activities of the employee during specific times.

Herbert Simon reported the converse—highlighting the importance of the firms green and the lines of authority within them, rather than the exchange activities of buying and selling. A labour contract gives the employer the authority to direct the activities of the employee, whereas a sale contract transfers property rights and does not bind the parties to further actions.

Firms represent a concentration of economic power in the hands of the owners and managers. There are thus two aspects of ownership of a firm: The owners direct the activities of other participants in the firm: Usually through hiring managers. Namely, whatever remains after the revenues, which are the proceeds from sale of the products, is used to pay employees, managers, suppliers, creditors, and taxes. Profit is the residual. The owners claim it, which is why they are called residual claimants.

Managers and employees are not residual claimants unless they have some share in the ownership of the firm. This division of revenue has an important implication. This is one reason we consider the firm as a stage, one on which not all the actors have the same interests.

Owners delegate control to managers share A part of the assets of a firm that may be traded. In large corporations, there are typically many owners. The owners of the firm are the individuals and institutions such as pension funds that own the shares issued by the firm. By issuing shares to the general public, a company can raise capital to finance its growth, leaving strategic and operational decisions to a relatively small group of specialized managers.

The separation of ownership and control results in a potential conflict of interest. Conflict of interest between owners and managers The decisions of managers affect profits, and profits decide the incomes of the owners. There are many things that managers can do to raise their pay at the expense of profits. An example is where managers seek to increase their own power and prestige through empire-building, even if that is not in the interests of shareholders.

Even sole owners of firms are not required to maximize their profits.

wage employment relationship model

Restaurant owners can choose menus they personally like, or waiters who are their friends. But, unlike managers, when they lose profits as a result, the cost comes directly out of their own pockets. Although Adam Smith had not seen the modern firm, he observed the tendency of senior managers to serve their own interests rather than those of shareholders. He said this about the managers of what were then called joint-stock companies: The Wealth of Nations, Aligning the interests of owners and managers There are many ways that owners can incentivize managers to serve their interests.

The board has the authority to dismiss managers.

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But although the shareholders, who are the ultimate owners, have the right to replace members of the board, they rarely do so. Shareholders are a large and diverse group that cannot easily coordinate to decide something.

wage employment relationship model

Occasionally, however, this free-rider problem is overcome and a shareholder with a large stake in a company may lead or coordinate a shareholder revolt to change or influence the board of directors and senior management. In spite of the separation of ownership and control, when we model the firm as an actor, we often assume that it maximizes profits. This is a simplification, but a reasonable one for many purposes: Owners have a strong interest in profit maximization: It is the basis of their wealth.

Market competition tends to penalize or eliminate firms that do not make substantial profits for their owners: When the ownership and control of a firm is separated, the managers become the residual claimants.

It is effective for shareholders to monitor the performance of the management, in a firm owned by a large number of shareholders. The shareholders are the residual claimants. Managers may choose to take actions that provide benefits for themselves at the expense of the owners. Such performance-related pay is a common method of incentivizing managers to maximize the value of their firm.

wage employment relationship model

When there are many shareholders, there is not only a coordination problem but also a free-rider problem, where every shareholder relies on others to do the costly monitoring and hence too little monitoring is undertaken. People participate in firms because they can do better if they are part of the firm than if they were not—for example, if they were self-employed.

As in all voluntary economic interactions, there are mutual gains. But just as conflicts arise between owners and managers, there will generally be differences between owners and managers on the one hand, and employees on the other, about how the firm will use the strength, creativity, and other skills of its employees. Costs of acquiring the inputs for the production process: Labour is one of these inputs. How much these inputs produce. The money the firm receives when it sells goods or services Our focus here is how firms seek to minimize the cost of acquiring the necessary labour to produce the goods and services they sell.

The employment contract is incomplete Hiring employees is different from buying other goods and services. When we buy a shirt or pay someone to mow a lawn, it is clear what we get for our cash. But a firm cannot write an enforceable employment contract that specifies the exact tasks employees have to perform in order to get paid. This is for three reasons: When the firm writes a contract for the employment of a worker, it cannot know exactly what it will need the employee to do, because this will be determined by unforeseen future events.

It would be impractical or too costly for the firm to observe exactly how much effort each employee makes in doing the job. Total maximum two years per employer and employee combination, then it automatically counts as a normal employment. It can still be ended for two reasons: Arbetsbristcancellation of employment, usually because of bad income for the company. There is a cancellation period of 1—6 months, and rules for how to select employees, basically those with shortest employment time shall be cancelled first.

Instead there are agreements between employer organizations and trade unions about minimum salaries, and other employment conditions. There is a type of employment contract which is common but not regulated in law, and that is Hour employment swe: The employee is expected to be answering the phone and come to work when needed, e.

They will receive salary only for actual work time and can in reality be fired for no reason by not being called anymore. This type of contract is common in the public sector. Young worker safety and health Young workers are at higher risk for occupational injury and face certain occupational hazards at a higher rate; this is generally due to their employment in high-risk industries.

For example, in the United States, young people are injured at work at twice the rate of their older counterparts. Youth unemployment rates tend to be higher than the adult rates in every country in the world. However, depending on the nature of the job, older workers may need to transition into less-physical forms of work to avoid injury.