Theory Of The Firm

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).

BREAKING DOWN '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. Corporation

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

    The branch of economics that analyzes the market behavior of ...
  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. Economics

    Industries That Thrive On Recession

    Recessions are not equally hard on everyone. In fact, there are some industries that even flourish amid the adversity.
  7. Investing Basics

    Economist Guide: 3 Lessons Adam Smith Teaches Us

    Learn three critical lessons about economics from 18th century philosopher Adam Smith, considered by many to be the father of economics.
  8. Fundamental Analysis

    5 Basic Financial Ratios And What They Reveal

    Understanding financial ratios can help investors pick strong stocks and build wealth. Here are five to know.
  9. Investing

    What Investors Need to Know About Returns in 2016

    Last year wasn’t a great one for investors seeking solid returns, so here are three things we believe all investors need to know about returns in 2016.
  10. Economics

    The Basics Of Business Forecasting

    Whether business forecasts pertain to finances, growth, or raw materials, it’s important to remember that a forecast is little more than an informed guess.
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 finance?

    "Finance" is a broad term that describes two related activities: the study of how money is managed and the actual process ... Read Full Answer >>
  6. What is the difference between positive and normative economics?

    Positive economics is objective and fact based, while normative economics is subjective and value based. Positive economic ... Read Full Answer >>
Hot Definitions
  1. Discouraged Worker

    A person who is eligible for employment and is able to work, but is currently unemployed and has not attempted to find employment ...
  2. Ponzimonium

    After Bernard Madoff's $65 billion Ponzi scheme was revealed, many new (smaller-scale) Ponzi schemers became exposed. Ponzimonium ...
  3. Quarterly Earnings Report

    A quarterly filing made by public companies to report their performance. Included in earnings reports are items such as net ...
  4. Dark Pool Liquidity

    The trading volume created by institutional orders that are unavailable to the public. The bulk of dark pool liquidity is ...
  5. Godfather Offer

    An irrefutable takeover offer made to a target company by an acquiring company. Typically, the acquisition price's premium ...
Trading Center