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. Gross Profit Margin

    A financial metric used to assess a firm's financial health by ...
  3. Microeconomics

    The branch of economics that analyzes the market behavior of ...
  4. Corporation

    A legal entity that is separate and distinct from its owners. ...
  5. Neoclassical Economics

    An approach to economics that relates supply and demand to an ...
  6. Aggregate Supply

    The total supply of goods and services produced within an economy ...
Related Articles
  1. Economics

    Economics Basics

    Learn economics principles such as the relationship of supply and demand, elasticity, utility, and more!
  2. Markets

    Great Company Or Growing Industry?

    Look at the big picture when choosing a company - what you see may really be a stage in its industry's growth.
  3. Options & Futures

    Nobel Winners Are Economic Prizes

    Before you try to profit from their theories, you should learn about the creators themselves.
  4. Fundamental Analysis

    Spotting Profitability With ROCE

    This straightforward ratio measures whether a company is efficient, money-making or neither.
  5. Bonds & Fixed Income

    Corporate Bonds: An Introduction To Credit Risk

    Corporate bonds offer higher yields, but it's important to evaluate the extra risk involved before you buy.
  6. Stock Analysis

    5 Reasons Thoratec Corp. Keeps Impressing Investors

    Learn about Thoratec Corporation and its position in its industry. Understand five key factors why the company has impressed investors.
  7. Entrepreneurship

    Startup Analysis: How Much Is Palantir Worth?

    Learn about the private company Palantir, its valuation and how its valuation was derived. Understand how the company operates and if it deserves the valuation.
  8. Fundamental Analysis

    Is India the Next Emerging Markets Superstar?

    With a shift towards manufacturing and services, India could be the next emerging market superstar. Here, we provide a detailed breakdown of its GDP.
  9. Stock Analysis

    Jawbone: An IPO You Should Have on Your Radar

    Learn about the company Jawbone and how it has become successful with multiple product lines. Understand the benefits of investing in an IPO
  10. Term

    Estimating with Subjective Probability

    Subjective probability is someone’s estimation that an event will occur.
RELATED FAQS
  1. How can individuals or businesses handle transaction costs for economic externalities?

    Externalities, also known as external economies, and transaction costs are two significant and evolving issues in contemporary ... Read Full Answer >>
  2. How valid is the notion of economies of scope?

    The concept of economies of scope is widely accepted in both managerial and theoretical economics. It proposes that it is ... Read Full Answer >>
  3. What is a diseconomy of scale and how does this occur?

    In economics, diseconomies of scale describes the phenomenon that occurs when a firm experiences increasing marginal costs ... Read Full Answer >>
  4. Does perfect competition exist in the real world?

    First, let's review what economic factors must be present in an industry with perfect competition: 1. All firms sell an ... Read Full Answer >>
  5. What is the utility function and how is it calculated?

    In economics, utility function is an important concept that measures preferences over a set of goods and services. Utility ... Read Full Answer >>
  6. What does marginal utility tell us about consumer choice?

    In microeconomics, utility represents a way to relate the amount of goods consumed to the amount of happiness or satisfaction ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Tiger Cub Economies

    The four Southeast Asian economies of Indonesia, Malaysia, the Philippines and Thailand. Tiger cub economy indicates that ...
  2. Gorilla

    A company that dominates an industry without having a complete monopoly. A gorilla firm has large control of the pricing ...
  3. Elephants

    Slang for large institutions that have the funds to make high volumes trades. Due to the large volumes of stock that elephants ...
  4. Widow's Exemption

    In general terms, a widow's exemption refers to the amount that can be deducted from taxable income by a widow, thereby reducing ...
  5. Wedding Warrant

    A warrant that can only be exercised if the host asset, typically a bond or preferred stock, is surrendered. Until the call ...
  6. Marlboro Friday

    A reference to Friday, April 2, 1993, when Philip Morris, the maker of Marlboro cigarettes, announced that it would be cutting ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!