Lesson 17: The Firm
Objectives: Students will discuss and learn about the basics of the firm. They will understand and
evaluate the firm’s role in the economy and compare this role to a fictional business.
Materials Required: Monsters Inc. “Scare Floor” Video
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Welcome back students. In this lesson we are going to discuss one of the important economic decision
makers: firms. As we learned in Unit 1, firms are entities that bring together resources to make goods
and services. In this lesson we will go through a run-down of the basic role of the firm in the economy.
Before we start, please watch the video “Scare Floor”, which is linked on the main page of the website.
We are going to be referencing that during this lesson.
Let’s begin. Firms have a very important role in the economy. Aside from creating goods and services,
they also exist to allocate—or redistribute—resources in our economy. Firms allocate resources through
three means:
1. Tradition
a. Only the top classes of society are the ones who get these goods or services. In some
societies, only the wealthy, the upper class, the leadership have access to some
products or services. This may be more commonly found in tribal societies or ancient
societies with a powerful leadership. Often resources are given to those at the top first
and then those resources slowly trickle down to the others within this society.
2. Command
a. The command system is an allocation method in which the government decides who
may or may not have something. For example: in modern North Korea, the government
often limits who has access to what. Some stores are not available to all North Koreans
and, in some cases, not all goods are available to all citizens. Some goods are reserved
for those who work within the government or in high positions.
3. Market System
a. The market system is the process by which consumers “vote with their dollars”.
Essentially, consumers decide what they want from the firms by buying it or showing
support with their money (think gofundme.com). If consumers buy a lot of something,
firms respond by producing more of it. If they choose not to buy it, then firms will cease
or limit production of the good/service.
While these are the three main ways of allocating resources, firms also allocate resources through
another mean, often in conjunction with the market system—personal characteristics. This is the
situation in which a firm allocates resources based on age, occupation, sex, strength, political party, etc.
While this may sound unfair, it’s actually quite common. Have you ever seen senior or military discounts
at a restaurant before? How about the fact that closer parking spaces are often reserved for the
disabled? Firms allocate based on personal characteristics all the time, although we rarely give much
thought to it.
With that, I want you to take a moment and think back to the “Scare Floor” video? In Monsters Inc., how
do you think they allocated resources?
Many times in the movie, it’s hinted that screams are a basic energy source. This probably means that
access to scream energy is based on consumer’s purchasing power, which would make the allocation of
scream energy done through the market system.
Now that we have talked about allocation, let’s discuss the role of the firm in terms of production. Firms
are created to maximize profits. People who create businesses do so to make as much money as
possible. This is done by making goods/services at the lowest cost and efficiently. Successful firms are
masters of efficiency. Consider this: households can produce their own goods and services. Sure, you
could plant a garden, make repairs to your home, add some additions, do some landscaping, and all
that. However, households tend to not do this. This is because the opportunity cost of households
producing their own goods and services tends to be quite high. In this, many households turn to firms to
do these things for them: provide them food (grocery store), make repairs (repairmen), add some
additions to the home (construction workers), and do landscaping (landscapers). Households tend to
only do domestic production, like chores (washing dishes, vacuuming, etc), but when it comes to larger
projects, households tend to defer to the firm’s expertise. Again, this is because firms are masters of
efficiency. They can do it at a low cost, which is low enough for a household to be willing to pay.
So here is a thought: in Monsters Inc., how is the firm efficient? There are several ways to look at this:
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Monsters Inc. tries to find the best scarers to maximize their scare potential.
Monsters Inc. as a fast process of door retrieval and removal.
The business has training programs for new scarers.
Monsters Inc. moved from scares to laughs at the end of the movie. As the movie said, kids were
harder to scare. In this, the efficient way getting energy was moving to the more potent laughter
energy, which required very little change (as most of their capital stayed), meaning costs stayed
low and energy efficiency increased.
Let’s keep going forward now. Now that we understand the role of the firm in allocation and production,
let’s discuss the role of the entrepreneur. What is an entrepreneur? An entrepreneur is the fourth
resource and exists to combine all other resources to make goods and services. Entrepreneurs create
firms with the purpose of making a profit. Let’s compare this back to Monsters Inc.
The owner of Monsters Inc., Waternoose, was an entrepreneur. As such, he had to bring together
resources to create this massive enterprise. So what resources did he bring together? Let’s look:
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Labor—he brought in only the best scarers of his time, such as Sully and Randall. They were the
labor force he needed to produce the scares. However, he also needed others who helped in
the company as well, such as the station runners like Mike, who managed the scare floor.
Land—Waternoose invested heavily in land. He needed natural resources to produce the doors,
the building itself, provide water for the showers, and even needed electricity (scare power) to
run his own company.
Capital—Waternoose had a large company filled with capital. The machinery, doors, training
areas, all built for the purpose of producing goods and services. As well, Waternoose also
invested in human capital (or monster capital?) by creating training exercises and investing in
Monsters University.
Now that we have discussed entrepreneurs, let’s into our last topic for this lesson: the three basic
economic questions all firms must answer. We discussed these before in Unit 1, although at the time we
discussed five. Many different economic resources will use either the three or five, but the main three
are the most important in my view and for this class, we’ll focus only on them.
Three Economic Questions all Firms must answer:
1. What will it produce: Firms decide what they want to make, but often in response to already
existing demands in the marketplace. If consumers want holiday sweaters for Christmas, some
firm out there will start making them. Demand influences supply.
a. In the case of Monsters Inc., the company makes scare energy. They may be pressured
by outside societal demands to continue their business because society requires that
energy.
2. How will it produce: firms have to ask themselves how they are going to produce something at
the lowest cost to maximize profit. Essentially, firms compare the value of their output
(good/services) to the value of their inputs (resources).
a. Think Monsters Inc. The company invests in the best scarers that bring out the most
scream energy. If you can’t scare, then you do another job that is more suited to you.
3. For whom: who is willing and able to buy it? Firms have to decide how gets their goods,
therefore they allocate goods based on discrimination: somebody will not be able to get this
good. It may be based on age, race, socio-economic class, etc.
a. This may not be a bad thing. Some examples of discrimination is: rated R movie, senior
citizen discounts, alcohol and cigarette age limits, height and weight limit on roller
coasters, etc.
b. Other times, the goods may be limited to only those who can afford the goods. Not
everyone is going to get a Ferrari. Just those who can afford it.
Closure: In this lesson, I wanted to cover the basics of the firm. In this, I hope that you have a
fundamental understanding of the role that firms play. As we move forward in Unit 3, this concept will
become more concrete.