Firms:

Firms are defined as economic organizations that purchase inputs and sell outputs. It is thus assumed that a firm's objective is to maximize profits. A firm's costs include both fixed and variable costs. In the short run there are both fixed cost and variable cost but in the long run all costs are variable.

Profit = Total Revenue (TR) - Total Costs (TC)

Total Cost = Total Fixed Cost + Total Variable Cost

Total Revenue = Price x Quantity Sold

Total Costs = Sum of all opportunity costs related to the production process

Opportunity Costs = Explicit Costs + Implicit Costs

Explicit costs of production include wages and salaries to employees, costs of raw materials and taxes. The Implicit costs of production include the value of time of owner/entrepreneur and the opportunity cost of financial capital invested in the firm, that is, the interest rate that is foregone.

"Economic profit" is the difference between total revenue and total cost, where total cost includes both explicit and implicit costs. In contrast, "accounting profit" is the difference between total revenue and explicit cost. Basically supply is primarily determined by the productivity of inputs, and the cost of the inputs. The production function shows the relationship between quantity of inputs and the quantity of output.

The short run refers to a period in which at least one input (usually capital) is fixed. This is in direct contrast to what is known as the long run where all inputs are variable. The short run production function shows a relationship between total output and inputs, when one input is varied and one is fixed. This is also known as the total product (TP). Average product (AP) is the average production per unit of variable input, and is equal to TP/L, where L is labor (the variable input). Marginal product (MP) shows the change in total output when input changes by one unit. Therefore, MP is the slope of the total product curve, and thus shows the productivity of labor.