The owners of a firm direct its members to perform actions aimed at generating profits. The purpose of this is not just the profit itself, but also to increase the overall value of the firm's assets, which belong to the owners.

Owner's Objective: Profit Maximization to Increase Asset Value

A significant consequence of the firm's revenue division is that when managers or employees contribute to increased revenues through their performance, the resulting profits primarily go to the owners. The employees and managers do not automatically share in these gains and only benefit if they receive a specific reward such as a promotion, bonus, or salary increase.

Asymmetric Distribution of Benefits from Increased Firm Revenue

Unlike managers, when a firm's owner makes a decision that reduces profits, the resulting financial loss directly impacts the owner's personal income. This occurs because the owner is the firm's residual claimant, meaning they are entitled to the profits that remain after all costs are paid.

Financial Consequence for an Owner Deviating from Profit Maximization

Because the profits of a firm legally belong to its owners, they are entitled to the residual income. This residual is what remains after all other contractual costs—such as payments to employees, managers, suppliers, creditors, and taxes—are deducted from the firm's revenues. This status makes the owners the firm's residual claimants.

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A firm is a key institution in capitalist economies, with an importance that rivals the government's. It serves as a specific method for organizing production, defined by several core characteristics:
* **Private Ownership of Capital:** One or more private individuals own the capital goods used for production.
* **Paid Employment:** The owners hire and direct labor, paying wages or salaries to the employees.
* **Owner's Property:** The goods and services produced are the property of the firm's owners.
* **Market and Profit:** The owners sell the output on markets with the primary objective of making a profit.

Firm

To cite the ebook, use The CORE Econ Team 2023 The Economy 2.0: Microeconomics Open access e-text https://core-econ.org/the-economy/.

To cite a unit, use The CORE Econ Team 2023 The Economy 2.0: Microeconomics Open access e-text https://core-econ.org/the-economy/ Unit [unit number] (url).

CORE Econ - The Economy 2.0: Microeconomics

Which of the following is NOT a characteristic of a firm?

What is the primary aim of selling the goods and services produced by a firm in the market?

Who directs the employees in a firm?

What is the main role of managers in a firm?

A firm's production process involves utilizing capital goods it owns or rents, like buildings and equipment, and employing workers. Through this process, the firm creates goods and services intended for sale in the market.

Firm's Production Process

The effective operation of firms is fundamentally dependent on the existence of two key institutions: markets and private property. These institutions create the necessary conditions for firms to conduct their business.

Essential Role of Markets and Private Property for Firms

A key feature that sets firms apart from other institutions like families or governments is their dynamic lifecycle. Firms can be created, grow, shrink, or be dissolved with remarkable speed. For instance, a prosperous firm can rapidly scale its operations, expanding from a small team to a large corporation, while an unprofitable one can quickly shrink and even cease to exist.

Dynamic Nature of Firms

This problem involves applying the definition of a firm to determine if a given entity qualifies as one. The process requires examining whether the entity possesses the key characteristics that define a firm, which may involve conducting external research for specific details about the entity.

Identifying Firms Based on Their Defining Characteristics

In capitalist economies, firms are the primary drivers of demand in the labour market, offering jobs to workers who constitute the supply side. This process of matching employers with employees is a foundational function of the firm, but it is only the first step in the employment relationship.

The Firm's Role in the Labour Market: Hiring

A firm is a structured and relatively permanent organization, distinct from temporary gatherings. A key aspect of its structure is a formal decision-making process that includes specific actors and defined hierarchies. This internal organization, which outlines key players and their roles in decision-making, provides a framework for directing the activities of its members.

Firms as Structured and Enduring Organizations

A fundamental question in the economics of the firm investigates why the predominant organizational structure involves capital owners hiring workers, rather than the alternative model where workers own the firm and rent the necessary capital. This question has been practically explored throughout history, with many attempts to establish alternative business models like worker-owned cooperatives.

The Question of Firm Ownership and Structure: Why Capital Hires Labor

In a capitalist economy, the most common productive organization is the traditional firm. However, other forms exist, such as worker-owned cooperatives, which represent a distinct type of firm where employees own the assets and select the management. Alongside these firm structures, there are also non-firm organizations like family businesses, non-profits, and government-owned entities, which are distinguished by their ownership models or primary objectives.

Types of Productive Organizations in Capitalist Economies

Owners as Residual Claimants of a Firm

In smaller business structures, it is common for the roles of owner and manager to be combined. In this model, the owner is not just a residual claimant but also takes direct responsibility for making the company's key operational and strategic decisions.

Owner-Managers in Small Enterprises

The dynamics between a firm's owners, managers, and employees are fundamental in determining key outcomes such as wages, work effort, and profitability. Furthermore, the collective result of these internal interactions has a significant influence on the overall economy.

The Firm's Internal Interactions and Their Economic Impact

Co-authored by John Micklethwait and Adrian Wooldridge, 'The Company: A Short History of a Revolutionary Idea' explores the historical evolution of the firm. Published in 2003 in New York by Modern Library, the book explains how this business structure developed into a highly important institution within modern economies.

The Company (Book by Micklethwait and Wooldridge)

A differentiated product is one that possesses unique characteristics that customers value and perceive as unavailable in competing products. This differentiation can be based on design, performance, quality, location, or associated services. The concept applies not only to manufactured goods like cars but also to service providers and retail stores, which can be distinguished by their product selection or the overall shopping experience. [1, 2, 8]

Differentiated Product

A product's demand curve, also known as a demand function, illustrates the relationship between the quantity of items consumers will purchase and every possible price point. [4, 7] A key feature of demand curves is their downward slope, which signifies that as a product's price increases, the quantity consumers demand for it falls. This inverse relationship also means that when a product's available quantity is low, it can be sold at a high price. The curve itself is derived from the willingness to pay (WTP) of each consumer, showing the number of consumers whose WTP is at or above any given price.

Demand Curve

Jack Cohen, the founder of Tesco, started his career in 1919 as a market trader in London's East End, where he famously used his cap-throwing technique to secure the best stall, or 'pitch'. His business philosophy was encapsulated in the motto, ‘Pile it high and sell it cheap’. In 1929, he founded his first Tesco grocery store, marking his formal entry into the retail sector.

Jack Cohen, Founder of Tesco

A demand schedule is a table that presents the quantity (Q) of a good that consumers will demand at various different price points (P).

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