Fundamentals of Business

Theory of Supply (enterprise/Firm)

Assumption
is that enterprises attempt to maximize profits.
This assumption is far less widely applicable than its demand theory counterpart. This is partly because firms are controlled by managers, therefore assumption of theory of consumers demand apply to managers as they are people, and will normally put their interests first before the companies. Managers may be, such as their own salaries, bonuses, power, and prestige, which may depend on the firm's size and acquisitions as much as on its profitability.

In the longer term, shareholders can exert their influence to induce firms to maximize long-term profits, as they would want a return on their investment. In the short run, the profit-maximization assumption leads to fairly clear predictions concerning the size of a firm's output and the way the firm would employ different factors of production, at least under conditions of perfect competition. Reasonable assumptions can be made as to the general relationship between the factors of production and an enterprise's output.

Production functions are the basis for determining how average costs and marginal costs (the costs of producing one more unit of output) vary with the size of the output. Once these variations are known, the firm can establish the most profitable level of output for any commodity, and the most profitable combination of factors of production.

While supply theory can provide reliable explanations and predictions of short-run behaviour by firms, predictions are more difficult once beyond the period in which capacity is assumed to be more or less fixed. By taking consumers components from demand theory and putting them together with firms supply components from supply theory; it is possible to construct models of how markets operate. The model of the firm under conditions of perfect competition is the origin of the theory of supply in microeconomics, in reality markets are not usually characterized by perfect competition, but by imperfect competition of one form or another, explained further in competitive forces (market forms).
Bottom-line
enterprise's survival and growth depend on profits, enterprises have to maximise their profits, hence the theory holds when we think of an enterprise as a separate entity, has its own interests and behave in its own way.
Decision makers do put their interests first as well as maintaining profitability of an enterprise as things like bonuses, dividends from shares all come from profits.

1.1.5 Supply curve shifts

When the suppliers costs change for a given output, the supply curve shifts in the same direction. This increase in supply causes the equilibrium price to decrease from P1 to P2. The equilibrium quantity increases from Q to Q2 as the quantity demanded increases at the new lower prices. Notice that in the case of a supply curve shift, the price and the quantity move in opposite directions. Conversely, if the quantity supplied decreases at a given price, the opposite happens. There are only four possible movements to a demand/supply curve diagram. The demand curve can move to the left and right, and the supply curve can also move only to the left or right. If they do not move at all then they will stay in the middle where they already are.

Possible movement of demand/supply curves