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Transcript of Employment Relationships Chapter 15 1 (c) 2010 Cengage Learning. All Rights Reserved. May not be...
1
Employment RelationshipsChapter 15
(c) 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
(c) 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
2
Introduction
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3
Big Blues
At IBM pay was competitive and employment was secure through the 1980s. A high
performing employee could count on an upward ascent
into management. After 1985, IBM’s fortunes fell. When Louis Gerstner came along in 1993, he became
the first CEO to upset other traditions—IBM would
finally see mass layoffs and division closings.
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4
What’s Next?
Employment relationships are as important as family ties for many of us, whether we are employees or employers. “Self-employed” just means there is no
boss between you andthe customer. Our study of employment will illustrate
how much light economics can shed on seemingly ordinary business relationships.
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5
MARKETS FOR LABOR
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Supply - Wages and Hours
Income is the opportunity cost of leisure time and vice versa—an extra hour of leisure comes at the price of an hour’s wages.
Thus, it takes theoffer of a higher wage to entice
people to work more hours. This gives rise to labor supply
curves like the one shown.
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7
Supply - Supply of Labor to the Market
Understanding the supply and demand for labor requires us to be quite clear about the exact market we are analyzing. The opportunity cost of supplying
labor depends on the worker’s alternatives. As a first approximation economists often assume
that workers are identical and model demand and supply conditions in Houston. For other problems
distinctions among skills are important.
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8
Supply - Human Capital and Long-run Supply
Productivity may be an accident of birth, like a unique musical talent, but most people must incur
costs to build up their earning powers. Your value to employers will depend in part on the skills you have
chosen to develop, which economists call investments in human capital. Investments in human
capital take place under uncertainty. A college education has general applicability but learning how
to operate a machine in a factory has much more specific applicability and therefore is a riskier
investment.
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9
Demand – The Employer’s Objectives
Marginal product is a measure of theextra output generated by adding
an additional unit of labor to a production process.
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Demand – The Employer’s Objectives
When the marginalis multiplied by the
price that the productproduced by the
labor will fetch in themarket we get the value of marginal
product (VMP) shownat the right.
As long as VMP>W, a firm will hire additional units of labor.
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11
Demand – The Employer’s Objectives
Labor’s VMP also rise with human
capital. A worker can acquire general human capital that increases productivity by
making investments such as formal education.
Productivity may also increase with experience
in a particular job. In general, increases in labor’s VMP will lead to an increase
in the demand for labor.
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12
Labor Market Equilibrium
Equilibrium in the labor marketoccurs where quantity suppliedequals quantity demanded. Inthis case, at a wage of $12 with50,000 units of labor employed.
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13
Labor Market Equilibrium
Shifts in demand and supply help in the analysis of many labor market phenomena at many possible
levels of detail:
• We could explain long-term trends in average wages and employment as a general rise in educational levels raises productivity, and thus both wages and employment.• As computers have made workers more
productive, the demand for them shifts upward and their wages and employment increase.
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14
What Supply and Demand Do Not Tell Us
So far so good, but there are many things about employment that supply–demand diagrams don’t help us to understand. Behind
supply and demand, however, we treated labor like a commodity that traded in spot markets. In particular:
1. We assumed that workers could easily learn about job vacancies and wages, and could move quickly and at low cost to push wages toward equilibrium.
2. We mentioned investments in human capital but did not explore their consequences.
3. We did not ask why long-term employment is common, even though markets and technologies change over the years in ways that could not have been foreseen when a relationship began.
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15
EMPLOYMENT AS A CONTRACT
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16
Information and Adjustment in Labor Markets
The assumptions underlying our basic supply–demand model are unlikely to hold completely in labor markets. Often, there are large numbers of
possible buyers and sellers, but neither people nor positions are standardized. Generally, we expect to see a range (distribution) of wages rather than a
unique equilibrium. By most measures labor markets adjust slowly to changes in supply or demand.
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17
Matches and Contracts
Labor markets are characterized by high information costs to both employers and employees. a labor market is a matching market, where the value a
relationship creates will depend heavily on how well employees and employers meet each others’
expectations. Either party can initiate the unmaking of a match, but only at a cost. Only a handful of
employment relationships are simple enough to be governed by written agreements. Professional sports
contracts or actors contracts are examples of such relationships.
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18
Incompleteness and Opportunism in Employment - Incompleteness
An employment relationship need not be memorialized in an enforceable contract, but even without one the parties become aware of
each other’s expectations and will likely attempt to meet them. Mutual expectations
give the employment relationship some aspects of one governed by a contract, but the need to accommodate change means that it must be a
highly incomplete one.
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Incompleteness and Opportunism in Employment - Efficiency Wages
Employment is a principal/agent relationship in which the worker (agent) receives assignments from the
employer or boss (principal). We now seek pay arrangements that can
induce ongoing effort by the employee. One possibility is for the employer to pay an efficiency wage that is
above the marketlevel.Where might we actually see efficiency
wages in operation? All else the same, they are more likely if monitoring is more costly.
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Incompleteness and Opportunism in Employment - Two-sided Opportunism
Both employers and employees can behave opportunistically.
A worker who understands the high costs of replacing him may choose a lower level of effort than one who is more easily replaceable. Employers who cannot be bound by enforceable contracts might do
likewise.
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21
LONG-TERM EMPLOYMENT
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22
Wages and Productivity - Lifetime PathsAll of the aforementioned difficulties in incomplete
contracting and opportunism might lead you to a mistaken
conclusion—that most employer–employee pairings
are of short duration. In reality, long-term
employment is common. This figure shows the
fundamental relationship that governs long-term
employment.
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23
Wages and Productivity - Characteristics of the Contract
So, why don’t wages match productivity over the worker’s years on the job, and why they exceed productivity only after some time has passed?
Backloading wages can induce greater effort from workers throughout the lifetime of their
employment relationship.
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Wages and Productivity - Employer Reputation and Enforcement
Why not fire the employee just before his wage would go above his productivity? An employer who
disappoints employee expectations in this way, however, can acquire
a reputation as untrustworthy, which would disadvantage it in the competition for workers. New
workers may be unwilling to start at low wages because they expect to be terminated early in their
careers.
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25
Internal Labor Markets - Classifying Jobs and Setting Pay
Promotions raise the question of why managements often restrict their searches to fill vacant positions to current employees, forgoing even a look at the many potential candidates outside the firm. A firm that limits its choices this way is said to utilize an internal labor market.
Job positions and descriptions of their responsibilities are a relatively recent development. Job classifications and pay based
on experience resolve some of the problems that come from team effort and allow management to avoid the difficult tasks of measuring and comparing the productivities of individual
workers, while also giving experienced workers the higher wages they expect under their unwritten long-term employment
contracts.
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26
Internal Labor Markets - Low-level Promotions
An internal labor market facilitates comparisons between candidates for a promotion. Unlike outside
applicants, their on-the-job conduct can be easily observed and their records are kept as part of ordinary
company business.
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27
Internal Labor Markets - Mid-level Promotions
Information may be harder to process for higher-level promotions than for lower-level ones. Moving upward, the information becomes harder to evaluate, and those
who choosethe winner may not be certain what weights to place on the different bits of information that are available. Part of the decision maker’s skill is in deciding which
of thatinformation to take seriously.
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28
Internal Labor Markets - High-level Vacancies
Now assume that there is a vacancy in a position such as chief
executive officer or chief financial officer. The board of directors’ decision to use the internal labor
market may not be a sound one, particularly if the vacancy arose because the lastholder of the position was fired.
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29
PAY AND INCENTIVES
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30
Designing Compensation Plans – Piece RatesThe apparel industry includes many small firms that
assemble garments from pre-cut pieces of fabric. Piece
rates are relatively rare in the economy, and their existence in this industry reflects certain
characteristics of the assembly job and the work environment:
1. It is easy to count the number of garments a worker completes and check their quality.
2. The job does not involve team production.3. The worker’s output is within her control and
is little influenced by random events.
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31
Designing Compensation Plans - Hourly Pay
Team production makes an individual worker’s productivity hard to observe because extra effort by a
single worker will usually have little effect on the team’s output. Workers
on teams may have little choice about their effort levels, for example, if they are on an assembly line
whose speed sets the pace for all of the workers. In cases like this we would expect to see the pay of a
team’s members depend on the actualhours the group is present in the workplace, as
opposed to piecework pay that allows random events to determine a member’s income.
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32
Designing Compensation Plans - Fixed Salaries
Supervisors are often on salaries that pay a fixed amount each month, independent of the hours they
work. In part the difference is due to observability. It is harder to enumerate a supervisor’s responsibilities
and measure his efforts. Simply being a supervisor usually indicates that a person is on a long-term
career path, and he will be motivated to make effort today for bonuses, promotions, and higher pay that he
may not receive for some time to come.
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33
Designing Compensation Plans - Shares and Commissions
The contingency-fee arrangement for paying the plaintiff’s
lawyer in Chapter 10 exemplifies a common payment mechanism called a share contract. Salespeople on
commission operate under share contracts, and sharecropping is a common
mode of farming around the world.
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34
Designing Compensation Plans - Tips
Restaurant servers, taxicab drivers, bartenders, and a few others earn much of their incomes in the form of tips or gratuities from customers they serve. Tips
resolve acombination of monitoring and incentive problems.
Tipping rewards the conscientious server for activities that increase the restaurant’s goodwill but
are likely to go unseen by the owner.
35
Designing Compensation Plans - Executive Compensation
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Performance-related pay can reward improvements in such measures of company performance as earnings
relative to its own past or relative to others in its industry. Measures
of performance should be within the control of executives, however. A performance measure should also be resistant to manipulation by the people being
rewarded for it.Common alternatives to performance-based pay (sometimes used alongside it) are based on the market
performance of the company’s stock.