Theory Of The Firm

AAA

DEFINITION of 'Theory Of The Firm'

A microeconomic concept founded in neoclassical economics that states that firms (corporations) exist and make decisions in order to maximize profits. Businesses interact with the market to determine pricing and demand and then allocate resources according to models that look to maximize net profits.

The theory of the firm goes along with the theory of the consumer, which states that consumers seek to maximize their overall utility. Modern takes on the theory of the firm sometimes distinguish between long-run motivations (sustainability) and short-run motivations (profit maximization).

INVESTOPEDIA EXPLAINS 'Theory Of The Firm'

The theory of the firm is always being re-analyzed and adapted to suit changing economies and markets. Early economic analysis focused on broad industries, but as the nineteenth century progressed, more economists began to look at the firm level to answer basic questions about why companies produce what they do, and what motivates their choices when allocating capital and labor.

Modern takes on the theory of the firm take such facts as low equity ownership by many decision-makers into account; some feel that CEOs of publicly held companies are interested not only in profit maximization, but also in goals based on sales maximization, public relations and market share.

RELATED TERMS
  1. Circular Flow Of Income

    The circular flow of income is a neoclassical economic model ...
  2. Corporation

    A legal entity that is separate and distinct from its owners. ...
  3. Microeconomics

    The branch of economics that analyzes the market behavior of ...
  4. Aggregate Supply

    The total supply of goods and services produced within an economy ...
  5. Neoclassical Economics

    An approach to economics that relates supply and demand to an ...
  6. Gross Profit Margin

    A financial metric used to assess a firm's financial health by ...
Related Articles
  1. Economics Basics
    Economics

    Economics Basics

  2. Does perfect competition exist in the ...
    Investing

    Does perfect competition exist in the ...

  3. Great Company Or Growing Industry?
    Markets

    Great Company Or Growing Industry?

  4. Nobel Winners Are Economic Prizes
    Options & Futures

    Nobel Winners Are Economic Prizes

Hot Definitions
  1. Conduit Issuer

    An organization, usually a government agency, that issues municipal securities to raise capital for revenue-generating projects ...
  2. Financing Entity

    The party in a financing arrangement that provides money, property, or another asset to an intermediate entity or financed ...
  3. Hyperinflation

    Extremely rapid or out of control inflation. There is no precise numerical definition to hyperinflation. Hyperinflation is ...
  4. Gross Rate Of Return

    The total rate of return on an investment before the deduction of any fees or expenses. The gross rate of return is quoted ...
  5. Debit Spread

    Two options with different market prices that an investor trades on the same underlying security. The higher priced option ...
  6. Leading Indicator

    A measurable economic factor that changes before the economy starts to follow a particular pattern or trend. Leading indicators ...
Trading Center