What Is a Firm in Economics?

By Staff WriterLast Updated May 27, 2020 7:33:47 PM ET
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A firm is an organization that does business for profit. There are many forms that a firm can take, from large corporations to a mom-and-pop business. Firms can have a single location or multiple places of business, but all locations have to have the same employer identification number (EIN) with the IRS to be considered the same firm.

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The Origin of the Word 'Firm'

The word "firm" began to show up in English around 1744, and most scholars believe that it comes from the German word "firma," which means "business." The German word came from the Italian word "firma," which means "signature." The origin of all three words is the Latin verb "firmare," which meant "to sign" or "to make firm."


We often use the word "firm" the most when referring to a business that provides a service, like a law firm or a graphic design firm. However, it can apply to any business that provides goods and services for profit. 


Firms vs. Companies


People often think that "firm" is synonymous with the words "company," "corporation," or "business," and, while they are somewhat similar, the words aren't interchangeable. What's the difference between a firm and a company? In business language, a company is just like a firm in the sense that all companies do business for profit.


The main difference between a company and a firm is that a one-person business doesn't usually count as a firm in business-speak. So the word "firm" refers to a business or company that has more than one owner and operates to make a profit.


Types of Firms


There are multiple structures that firms can operate under. A partnership is a business that has two or more owners, and there's no limit to how many partners a company can have. Under a partnership, the owners or partners are personally responsible for the obligations of the business, and each partner owns a stake in the company.


A corporation is a business structure where the finances of the company are separate from the finances of the owners. Owners of a corporation aren't personally responsible for the performance or obligations of the firm. Corporations can borrow money, pay taxes, and enter into contracts much like individuals can. A financial cooperative is another type of firm where the owners aren't directly liable, but investors can give the company direction on how to operate.


Resources That Firms Use


Firms and companies rely on different types of resources to produce the goods and services that they offer. Companies use natural resources, which are things like land, wood, water, and other materials that come from nature. Firms often take these natural resources out of their original form and turn them into something else.


Capital is another resource that firms use that consists of money and other financial tools that owners and partners use to invest in the business. Human resources are how employees put their skills and labor to work to create the goods and services that the company offers. Entrepreneurship is the hardest resource to understand because it's made up of the ideas and thoughts that partners and owners put to use in their firms.


The Theory of Firms


Economists have written pages and pages about the theory of firms over the decades, but when you break the theory of firms down to its most basic meaning, it's pretty simple: firms exist to make as much profit as they can. People go into business because they're passionate enough about a good or service that they can provide that they want to make a living doing it. 


Even as exciting as providing a good or service may be, it's still a job for the owners of a firm, and they want to earn as much money as they can. Scholars have debated how a firm can make the most money and how big a firm should be to make money, but their theory is pretty simple and easy to understand without making it too complicated.


Functions of Firms


Firms and companies have multiple functions that they offer to society. The most obvious function of a firm is to provide a good or service that people need. These can be physical items like furniture or consumable items like food, or they can be a service like legal representation.


Another function of a firm is to provide wages for the people who work at the company, and some companies also provide benefits like health insurance and opportunities to invest toward retirement. Firms also contribute tax revenue to the government that helps authorities provide services to people all over the community.