Part II of this text analyzed consumer choices – the demand side of the market for goods and services. Part III now deals with the supply side. This chapter explains the nature of business firms and the relations among entrepreneurs, owners, and managers. The chapter then describes the firm's cost and revenue functions and its profit-maximizing level of production.

WHY FIRMS? ENTREPRENEUR, OWNER, MANAGER

Business firms are artificial creations, organized to produce goods and services for the market. But individuals or groups can produce for the market without creating a firm. So if firms are not essential, why are they formed?

Firms exist to take advantage of team production while minimizing costs of contracting. All but the simplest production processes call for team effort. Manufacturing typically requires machine operators, inspectors, and clerks together with nonlabor inputs such as electricity, materials, and buildings. The same holds for mining, transportation, retail sales, and so forth. Still, team production could take place without forming a firm. A movie could be produced via a multilateral contract specifying the types and quantities of inputs to be provided, at stated places and times, by the producer, director, actors, camera operators, and so on. The contract would also need to define each person's financial obligations and rewards. Such multilateral deals do occur. But the high costs of negotiation and enforcement make them rare. If instead a firm produced the movie, only bilateral contracting would be required.