Economics of Firms: Definitions, Incentives, and Organizational Behavior

The Firm

A business organization that hires people, purchases resources, and produces goods or services, usually aiming to maximize profit

Specialization (Division of Labor)

When different producers focus on carrying out specific tasks in the overall production process

Asymmetric Information

When one party in an economic interaction knows important information that the other party does not (e

Firm-specific Assets

Valuable resources (like specialized skills, networks, or friendships) developed on the job that lose value to both the employee and the firm if the employment relationship ends

Incomplete Contracts

An employment agreement that cannot legally cover every possible task or situation that might affect the exchange between the employer and employee, especially regarding effort

Organizational Behavior (OB)

The study of how individuals, groups, organizational structure, and processes influence behavior inside a company

Principal Agent Problem

A conflict of interest that occurs when one party (the agent, like an employee) acts on behalf of another (the principal, like an owner), and their motivations aren't perfectly aligned

Employee Engagement

The degree to which an employee's behavior matches company goals, reflecting their enthusiasm and involvement in their work

Organizational Culture

The shared social understanding, implicit rules, norms, and values that guide how employees behave, especially when managers aren't watching

Flexible Labor Market

A job market designed to change quickly in response to economic conditions, making it easier for employers to adjust the workforce and for workers to switch jobs

Socialization

The formal process by which an organization introduces new employees to its values, assumptions, and expected attitudes, aiming for a proper fit within the culture

Diversity

The wide range of human differences, including physical, cultural, ethnic, gender, age, ability, and background factors

Human Capital

The total knowledge, attributes, skills, health, and experience held collectively by the workforce

Skill

A learned talent developed specifically to perform a task

Ability

A person's innate or natural capacity to perform mental or physical tasks and learn new skills

Soft Skills

Essential abilities that are easily transferable across different jobs, such as problem-solving, critical thinking, adaptability, and social skills

Hard Skills

Specific, technical knowledge required to perform a job, often listed as requirements (e

Attitudes

Learned feelings and beliefs that determine behavior, defining a person's predisposition toward people, situations, and their job

Personality

A stable combination of feelings and behaviors shaped significantly by genetics and environmental factors

Locus of Control

How much a person believes their actions and effort determine the outcomes they experience ("Internals" believe they are in control; "Externals" believe outside forces are in control)

Self-Efficacy

A person's specific belief, which is learned, about their own competence and ability to succeed at a particular task

Emotional Intelligence (EI)

The ability to recognize one's own feelings and the feelings of others, manage those emotions, motivate oneself, and navigate relationships successfully

Perception

The cognitive process where a person selects, organizes, and interprets environmental information (stimuli) to make sense of the world

Transparency Illusion

The mistaken belief that our internal thoughts, intentions, and effort levels are obvious and clearly understood by others

Schemas (in Psychology)

Mental frameworks (like blueprints) used to structure thoughts and quickly organize descriptions of people, situations, or objects

Stereotyping

The mental act of categorizing or simplifying individuals based on limited information; while efficient for processing, it is a precondition for social bias

Prejudice

Negative feelings about a person or group that persist even when shown information proving the initial stereotype is inaccurate

Discrimination (ABC Model)

The observable behavior or actions taken toward an individual, stemming from prejudiced feelings and stereotypes

Fundamental Attribution Error

The tendency to wrongly emphasize a person's character (internal factors) while ignoring situational pressures (external factors) when explaining others' behavior

Self-serving Bias

The tendency to attribute success to one's own efforts (internal factors) and blame failures on outside circumstances (external factors)

Employment Rent (Cost of Job Loss)

The total extra value a worker receives from keeping their current job compared to their next best option (like unemployment or a new job)

Reservation Wage

The absolute lowest wage a worker is willing to accept; at this wage, the worker doesn't care if they keep the job or lose it

Involuntary Unemployment

Being unemployed but actively wanting a job at the same wages and working conditions currently available to employed people

Multi-tasking Problem (Holmström & Milgrom, 1991)

When incentives focus heavily on easy-to-measure tasks (e

Crowding-Out

A phenomenon where introducing external rewards (like money) reduces or eliminates a person's pre-existing internal motivation (like purpose or altruism) for doing that activity

Hidden Action Problem

A conflict in the Principal-Agent model where the agent takes a specific action (like exerting effort) that the principal cannot see or prove, creating a misalignment of interests

Motivation

The desire and willingness to exert discretionary effort to perform a job

Direction (Motivation)

The specific task or goal an employee chooses to focus their effort on

Intensity (Motivation)

How strongly committed an individual is to a chosen path, or the amount of effort they exert

Persistence (Motivation)

The duration for which a motivated behavior or level of effort is sustained

Hygiene Factors (Herzberg)

External job aspects (like salary, working conditions, security, and company procedures) that must be adequate to prevent dissatisfaction, but do not actively motivate employees

Motivators (Herzberg)

Internal job aspects (like achievement, recognition, responsibility, and growth opportunities) that actively drive employee satisfaction and positive motivation

Job Design

The continuous and dynamic process a manager uses to structure a job, determining the specific tasks and the level of authority an employee receives

Job Range

The total number of different tasks an employee performs in their job

Job Depth

The level of freedom or authority an employee has to make decisions about how to do their job and structure its outcomes

Job Enlargement

Increasing the number of tasks an individual handles, thereby increasing job range but not necessarily increasing their decision-making power (depth)

Job Enrichment

A strategy that increases job depth by giving employees more control, discretion over work methods, direct feedback, and responsibility for entire tasks

Self-Managed Teams (SMT)

A group-level job design where the team collectively handles all aspects of their work—setting assignments, managing the entire process, selecting members, and evaluating performance

Organizational Justice

The overall feeling among employees that they are being treated fairly within the workplace, measured across four dimensions

Distributive Justice

The feeling that the final rewards (like pay or bonuses) are distributed fairly compared to others' efforts and outcomes

Procedural Justice

The feeling that the formal methods and rules used to make decisions (like pay raises or promotions) are fair, consistent, and unbiased

Psychological Contract

An implicit, unwritten agreement between an employee and the organization detailing what each expects to give (effort, loyalty) and receive (pay, security) from the other party

Deficiency (Evaluation)

When a performance evaluation fails to measure or cover all necessary parts of an employee's job

Contamination (Evaluation)

When a performance evaluation includes measuring activities or outcomes that are not actually part of the job

Reinforcement

A core learning principle where desirable consequences make a behavior more likely to be repeated, and undesirable consequences make it less likely

Punishment

An undesirable consequence applied after a behavior to decrease the likelihood of that behavior happening again

Employee Misbehavior

Behavior where employees purposely break important organizational rules, policies, or expectations

Antecedent (Misbehavior Model)

A pre-existing condition (eg , stress, unfair pay, weak controls) that provides the opportunity, motivation, or justification needed for an employee to engage in misconduct)

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Mediator (Misbehavior Model)

The psychological or structural factors (like job dissatisfaction, moral rationalization, or group norms) that bridge the gap between an antecedent condition and the actual act of misbehavior

Goodhart's Law

The principle that once a measurement (metric) is turned into a specific goal (target), it stops being a reliable way to assess performance, as people will try to game the system

ABC Model of Attitudes

A social psychology framework explaining that attitudes are composed of three parts: Affective (feelings, like prejudice), Behavioral (actions, like discrimination), and Cognitive (beliefs, like stereotypes)

Attribution Theory

Explains how people try to determine the root causes of events or behaviors, often categorizing them as internal (personal traits) or external (situational factors)

Pygmalion Effect

A self-fulfilling prophecy where setting high expectations for employees actually leads them to perform better and achieve those high results

Golem Effect

The opposite of the Pygmalion Effect: when low expectations of performance result in the employee fulfilling that prophecy by performing poorly

Taylorism (Scientific Management)

An early management approach that standardized jobs into extremely limited tasks (low range) to maximize efficiency, based on the assumption that workers would only perform to avoid punishment

Job Characteristics Model (JCM)

Explains that five core job traits (Skill Variety, Task Identity, Task Significance, Autonomy, Feedback) lead to positive work outcomes by making the job feel psychologically meaningful and responsible

Vardi and Weitz Model of Organizational Misbehavior

A framework proposing that employee misconduct occurs when Antecedents (conditions) create the opportunity or motivation, which then leads to the misbehavior through Mediators (like job dissatisfaction or moral rationalization)

The Big 5 Personality Dimensions

Five fundamental personality traits used to understand and predict behavior: Extroversion, Emotional Stability, Agreeableness, Conscientiousness, and Openness to Experience.