The assumption that firms maximize profit allows economists to develop the theory of the firm in a mathematical framework with an elegance and simplicity that would otherwise not be possible. Before we accept this assumption, however, let us take a look at a different assumption, that organizations simply try to survive. The assumption that members of the firm want the firm to survive may be a more realistic assumption than the assumption that firms attempt to maximize profits. The continued existence of the firm provides benefits to owners, managers, and workers. Members of the firms can and do try to eliminate other members whose actions threaten the survival or health of the firm. Because survival of the firm requires profit, the assumption that members of the firm want the firm to survive is equivalent to an assumption that the firm attempts to make a profit. Further, the assumption of survival will lead to profit maximization in industries that have easy entry and exit.

The assumption of survival reveals similarities between nonprofit organizations and for-profit organizations. It is not hard to see some of the similarities. A not-for-profit organization faces the same three constraints that a for-profit organization does: supply curves for resources, a production function, and some sort of demand curve for output. For example, many art museums exist as nonprofit, private organizations. They must buy resources (hire guards and curators, pay utility bills, etc.), they produce a product (a service of art exhibition), and they must obtain money in order to continue in existence (donations and entrance fees).

The major difference between a for-profit organization and a nonprofit organization is that the former announces that its goal is to make a profit, and then is forced by the constraints to produce a product that is valuable to someone. The latter announces that its goal is to produce a product that is valuable to someone, and then is forced by the constraints to cover its costs. But if an organization covers its costs, its revenues must exceed costs, which means it is making a profit.

One could imagine an art museum organized as a for-profit corporation. One would expect it to charge an admission fee that would maximize profits, and one expects this to be higher than the fees a not-for-profit museum would charge. A not-for-profit museum wants to encourage art enjoyment, and higher fees interfere with this goal. But then why do museums charge any fees at all? A zero fee would maximize the number of visitors and art enjoyment (ignoring problems of congestion). At one time few museums charged fees. Now, most museums could not survive without fees.

Because both not-for-profit and for-profit organizations face the same three constraints, the actions of one can be hard to distinguish from those of the other if the constraints allow only a small area of profit. As a result, the economic theory of the firm describes, with a few minor modifications, the options open to not-for-profit organizations. (A for-profit organization can be at a competitive disadvantage to a not-for-profit organization when the not-for-profit status encourages donations and donations are an important source of revenue.)

We next discuss what a firm must do to make as much profit as possible.

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Copyright Robert Schenk