Chapter 8, Problem 1CQ

To determine

Effect of residual income claimant behavior of the owners of a firm.

Explanation of Solution

The owners, whose income depends on the profit of the firm, are called as residual income claimants. An increase in gap between (positive) total cost and total revenue increases the income of the owners. Therefore, the owners would have a great incentive to increase the percentage of profit of the firm. The property right to the residual income of the owners affects their incentive to produce efficiently with a lower cost. In order to attain this, the owners try to allocate the resources efficiently and induce the workers to produce more by giving incentives to them. This would help to produce maximum at a minimum cost and increases the level of profit.

The owner’s property right to residual income also affects the supply of goods. They try to increase the value of product relative to the cost of production. This is because if people over value a product relative to its cost, the level of profit increases by raising its price. Thus, the owners adopt some strategies to increase the value of their product and maintain the cost of production as lower. These actions are important for the owners who are residual income claimants. This is because their income depends on the level of profit of the firm.