Definition of a Firm in Economics

The meaning of a firm in economics differs from the commonly known or layman’s definition of the firm. We understand a firm as a business, organization, or company that deals with the production, distribution and sale of goods and services. But how is this term defined from an economics perspective?

In economics, a firm holds important position as at the firm level managerial decisions are taken. In common language a firm is considered as a manufacturing unit involved in production of goods. The scope of the term firm in economics is broad. It represents any business organization that provides goods and services to consumers.

Definition of the Firm

A firm can be defined from an economics perspective as a unit of production that employs factors of production (or inputs) to produce goods & services under given state of technology. When we talk about a firm, we refer to an independently administered business unit that is responsible for producing goods and/or services. It is a center of control where the decisions about what to produce & how to produce are taken. We can also describe a firm as a business entity that employs productive resources to produce goods and service.

Characteristics of a Firm

Based on the above definitions of the firm, there various characteristics or features that can be identified:

  • Decision Making Unit: In the field of economics, a firm is a place where all decisions related to production are made regarding what, where & how much to produce. Economics as field of study primarily deals with the productive process where scarce resources are utilized to meet unlimited human wants. The firm plays an integral role in decision making processes related to how, when and for whom goods and services should be produced.
  • Hiring Manpower: The firm is a place where manpower is hired for production. Firms employ labor and capital to produce and goods and services. Each firm requires workers who carry out actual activities involved in the production and distribution of goods.
  • Brings Together all Factors of Production: The firm is a place where all the resources of production are brought together, production is done as well as sale & distribution of the manufactured product is carried out. Land, labor and capital are utilized by the firm as inputs to produce goods and services.
  • The state of technology is defined by the firm’s production function: Technology is used by the firm to produce goods and services. Thus, a firm’s production function determines the limits within which technology is used to facilitate the production process.

The ultimate goal of a firm is to maximize profits by engaging in the productive processes of manufacturing, distributing and marketing goods and services. Every firm aims to maximize profits in the long run irrespective of the short term profits or losses. A group of several firms dealing with similar products and/or services creates an industry. For example, companies that deal with the sale of household and consumer goods such as fruits, vegetables, cereals, detergents, clothes, electronics, and furniture belong to the retail industry.

Each firm makes its own decisions on what to produce, how to produce it, and how much to charge for it; but those decisions are affected by what other firms in the industry are doing. For instance, one firm has no option but to lower product prices when all other firms in the industry are also lowering their prices; otherwise it will lose customers to its competitors.

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