A firm is a decision making unit, which has the power to make decision within the area under its control i.e. a person or group of persons who starts business, manages it and takes responsibilities. The basic aim of the firm is to maximize profits i.e. to minimize total cost.A firm can maximize its profits in three ways:
By increasing the selling price
In this way firm can maximize its total revenue and the difference between total cost and total revenue is widened. But this method is not free from danger. There is a possibility of contraction in demand as price increases and total revenue instead of increasing may decrease.
By diminishing cost of production
A company can maximize profit by diminishing cost of production but the firm has to changes the method of production i.e. it has to adopt new and better means of production.
By decreasing the selling price
A business can increase its total revenue by decreasing selling price because decrease in price may cause extension in demand but price can be decreased up to some extent and below the normal profit price cannot be decreased. So the best way is to minimize cost of production.
Basic Problems of Firm
Choice of Industry
Every business faces the problems in which industry to invest because the basic aim of the firm is maximize profits so the industry in which more profits are possible i.e. Demand for goods in greater it invests its capital.
Choice of Place
The second problem is the choice of place for the factory. For this purpose it is seen that weather the raw material is available or not, power i.e. electricity or gas to run the machinery is available or not, weather necessary labor force available, and the markets are near. The means of transport and communications developed and swift or not.
Choice of Scale of Production
Another problem for the firm is the choice of scale of production. Scale of production may be large or small. Both the scales have merits and demerits. It will adopt that scale of production which maximizes its profits. The choice also depends on the financial resources of the Company , ability of organizer and experience, extent of the market and nature of work.
Decision of Output
Firm has to decide that what amount of output should be produced. It will produce that amount of output which maximizes its profits. Firm’s profits are maximizing where original cost is equal to marginal revenue.
Firm tries to maximize its profits and for this purpose it has to diminish its cost of production. Company faces the problem of choice of method of production i.e. choice between labor intensive and capital intensive method. It will adopt that method which diminishes its cost of production.