What is a firm? Definition and meaning

A firm is a commercial enterprise, a company that buys and sells products and/or services to consumers with the aim of making a profit. In the world of commerce, the term is usually synonymous with ‘company’, or ‘business’ as in “She runs a forex trading business.”

A business entity such as a corporation, limited liability company, public limited company, sole proprietorship, or partnership that has products or services for sale is a firm.

Law, accountancy and management consultancy partnerships are known as firms, and are rarely referred to as companies.

What is a firm?A firm is any organization that brings together resources to produce goods or services in the pursuit of profit. It can take several different forms.

According to the Online Etymology Dictionary, in 1744, the term first emerged in the English language with the meaning of ‘business house’. It is believed to have come from the German Firma meaning ‘a business, name of a business,’ which came from the Italian word Firma, meaning ‘signature’ and Firmare ‘to sign’.

In early Latin, Firmare meant ‘to make firm, affirm’ and then in Late Latin had the added meaning of ‘confirm (by signature)’.



‘Firm’ in other languages: une firme (French), firma (Spanish, Portuguese, Italian, German, Danish, Norwegian), фирма (Russian), 事務所 (Japanese), 一间公司 (Chinese), شركة (Arabic), fast (Swedish), yritys (Finnish), suatu perusahaan (Indonesian), and kampuni (Swahili).

BusinessDictionary.com defines the word ‘firm’ as follows:

“A commercial organization that operates on a for-profit basis and participates in selling goods or services to consumers. The management of a business firm will typically develop a set of organizational objectives and a strategy for meeting those goals to help employees understand where the company is headed and how it intends to get there.”

Theory of the Firm - Transaction costsThe model above shows institutions and market as a possible form of organization to coordinate economic transactions. When the external transaction costs are greater than the internal ones, the firm will grow. When it is the other way round, it will be downsized by outsourcing, for example. (Data Source: Wikipedia)

What is the Theory of the Firm?

The Theory of the Firm comprises several economic theories that explain and predict the nature of the firm (company), including its structure, relationship to the market, behavior, and its very existence.



The theory aims to answer the following questions:

Existence: why do firms emerge. Why aren’t all transactions in the economy mediated over the market?

Boundaries: why is the boundary between the market and firms located exactly there, in relation to output variety and size. Which transactions are negotiated on the market and which are performed internally?

Organization: why are firms structured the way they are, with hierarchy, a central point, etc.?

Heterogeneity of Firm Actions/Performances: why do firms do things, what drives them?

Evidence: what tests currently exist for respective theories?

Adam Smith (1723-1790), a Scottish moral philosopher and pioneer of political economy, known by many today as the ‘father of modern economics’, discussed firms in his work – The Wealth of Nations. He established that in the world of manufacturing, they were more efficient in producing than laborers or craftsmen were when working individually.

Mr. Smith explained that a manufacturing firm used a more intense form of division of labor than can be coordinated through market exchange. His view of firms in terms of their different kind of division of labor was widely accepted by classical economists.

Karl Marx (1818-1883), a Prussian (German) philosopher, economist and revolutionary socialist, wrote in his work – Das Kapital – about the Smithian type of manufactures and how they exploited the more intense division of labor.

Mr. Marx found the division of labor in firms highly problematic, because the individual worker, he believed, was separated from the end product and therefore was ‘alienated’ through work performed within the manufacturing process.

Regarding Mr. Marx’ attitude to the economic aspects of efficient firms, Per Bylund writes in Mises Daily Articles:

“Marx was obviously not very interested in the economic analysis — division of labor increases productivity and increases prosperity for all individuals involved as well as society as a whole — and so focuses solely on the problem he identifies.”

Over the following century, sociologists and economists have contributed extensively to the Theories of the Firm.

Put simply, firms exist as an alternative system to the market-price mechanism, when producing in a non-market environment is more efficient.

For example, in a labor market, it may be costly and difficult for commercial entities to engage in production when they have to take on and lay off workers, depending on levels of demand and supply.

For employees, it is costly and inconvenient to shift companies on a daily basis looking for better alternatives.

Companies, similarly, will find it costly to seek out new suppliers every day. That is why firms engage in long-term contracts with their workers and suppliers to minimize the cost or optimize the value of property rights.

Other meanings of ‘firm’

Fairly Hard: as an adjective, the word may refer to anything that has a solid, virtually unyielding surface or structure, as in “I am looking for a mattress for my bed that is reasonably firm, but not too hard.”

The Ground: in horse-racing, when the TV commentator says that the going is ‘firm’, he or she means the opposite of soft – it has not rained and the ground is fairly hard.

Attitude, Belief: when used as an adjective in an abstract sense, it refers to something that is unlikely to change and is strongly felt, as in “He is a firm believer in delegating responsibility.”

Football (Soccer): according to urbandictionary.com, in the UK the term may refer to a group of football hooligans, usually consisting of between 200 and 300 people. Some ‘firms’ are considerably bigger.

Discipline: A teacher with a class of twenty adolescents may be given the following advice by his or her head of department: “You need to be firm so that they all understand who is boss, but also caring. Above all, try to get them to take pride in what they do.”

To Harden: as a verb, it is commonly used when talking about one’s body, as in “I really need to firm up my abdominal muscles, perhaps some sit-ups might help.”

Video – What is a firm?

In this video, Christopher Coffman explains what a firm is. The recording is very basic – all you see is his head talking. However, he explains everything very clearly, with lots of examples.