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Managerial Economics and Organizational Structure

    1. Always Round Tire tries to base its promotions on seniority (where education and training requirements are not necessary). The company finds that this system seems to work most of the time with shop floor supervisors and team managers. However, the system breaks down for higher-level positions. Why?


Always Round Tire uses the principle of seniority because it is simple to apply at the lower levels as it is the most objective. It leaves no scope for favoritism or nepotism, giving respect to age and experience. It is in accordance with the established cultural aspects and practices in a blue collar society; a younger person does not become a boss of the older and more experienced person. Having said that, seniority does not necessarily coincide with age, a younger person who joined the firm at an early age may be senior to someone who joined late in life. It provides a democratic approach, because it gives a chance of promotion to everybody irrespective of merit, everyone is bound to become senior with the passage of time. It provides an established and defined pecking order which is observable and understandable by all employees, therefore, seniority principle is readily accepted by many.

But the principle of seniority has many drawbacks, those who are senior are not necessarily the most qualified for upper-level promotion where education and training are a requisite. Experience is gained by a person in the first few years of employment with a firm, but afterwards experience does not increase indefinitely with the length of employment. It is said that ten years experience is nothing but one year’s experience repeated ten times. Tremendous opportunity for inefficient and conservative individuals may get promoted to upper management which would adversely affect the over-all performance of Always Round Tire, thus as a sole basis for promotion seniority principle is not rational or just. Hard work, efficiency and initiative of an energetic individual is not rewarded. Conversely, physically weak, aged and less energetic individuals are promoted to higher positions where hard work, alertness and energy are required.

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Always Round Tire should use a blended solution of seniority and merit based promotion system, similar to the one used in the military. For promotions to occur, one the individual must have time in service and time in grade, thereby providing for the seniority aspect. Secondly, the individual needs to show knowledge and have received and passed job specific and service specific training, thereby providing for the merit aspect. If in both cases the individual surpasses the collective group, then and only then will a promotion occur.

Selection and promotion to upper-level management will fail if seniority based promotion is solely used; you are not getting your best and brightest, you are getting the one who out lived everyone else.

Brickley, J., Smith, C., Zimmerman, J. (2009). Managerial Economics and Organizational Architecture, Fifth Edition. McGraw-Hill/Irwin.

    1. What are the factors that favor high incentive pay for an employee? Explain which of the five factors is the most important.


According to Brinkley, Smith, & Zimmerman, 2009, the following are factors which favor high incentive pay.

High incentive pay is favored when profitability of additional effort is high, in other words the value of output is sensitive to the employee’s effort, hence greater the effort by the employee, equals greater production. High incentive pay is favored when employees are willing to tolerate high financial risks are not very risk averse, understood as an employees’ pay is tied to production and if production declines so does the employees’ pay; conversely if production increases so goes the employees’ pay, therefore the employee accepts the belief that the benefits outweigh the risk. High incentive pay is favored when the risk beyond the employees’ control is low, meaning the employee has some control over the factors impacting their production. High incentive pay is favored when an employees’ response to increased incentives is high, therefore increasing the incentives would increase the employees’ production and effort, up to an optimal point were it ceases to provide any additional impact. High incentive pay is favored when the employee’s output can be measured at low cost, within this factor, the firm would provide an incentive which is not counterproductive to profit gain nor financially adverse to the overall operation of the firm. Another possible reason for incentive pay is the bundling of tasks in an attempt to encourage the employee to exert effort on other tasks, such as customer service. These factors reflect the trade-off between incentives and inefficient risk bearing. When they are met, the benefits of increased incentives are large relative to the risk-bearing costs.

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In explaining which of the five factors is the most important, a reflection back to the components of organizational architecture provides the answer; all are equally important being applied with varying degree. As with the three legs of the organizational architecture stool (Brinkley, Smith, & Zimmerman, 2009), a balanced approach is needed to succeed.


Brickley, J., Smith, C., Zimmerman, J. (2009). Managerial Economics and Organizational Architecture, Fifth Edition. McGraw-Hill/Irwin.


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