Traditional economic analysis assumes that firms set out to maximise profits, where profits are defined as the excess of total revenue over total costs.
This analysis treats the opportunity cost of a firm’s resources as a part of its fixed costs. The opportunity cost (both explicit and implicit) is known as normal profit.
Profits above this level are known as supernormal profits.
A firm maximises profits by choosing a level of output such that marginal revenue is equal to marginal cost.
For many larger firms, where day to day control is delegated to managers, a principal-agent problem may arise if there is a conflict between the objectives if owners (principals), and those of the managers (agents).
This may lead to satficing behaviour and X-inefficiency.
Satisficing behaviour is where an does just enough to satisfy the principal.
X-inefficiency is when costs for a given level of output are above the long run average costs for that level of output. Alternatively, it can be expressed as when a company is producing within its PPF curve.
William Boumal suggested that managers may set out to maximise revenue rather than profits; others have suggested that sales or growth of the firm may be the managers objectives.
For an individual firm, productive efficiency can be regarded as having been achieved when the firm is operating at minimum long run average cost.