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Reading Selections:
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The business firm is the productive unit in an exchange economy. In order to survive, a firm must deal with three constraints: the demand for its product, the production function, and the supply of its inputs. When the firm successfully deals with these constraints, it makes a profit. These readings explore the assumption that firms maximize profits, pointing out some of the ambiguities of this assumption. It then explores how the rules of maximization apply to the firm. It considers two ways in which the maximization principle can be used: to determine the proper levels of inputs or to determine the proper level of output. The first leads to the rule that marginal resource cost should equal marginal revenue product, and the second to the rule that marginal cost should equal marginal revenue. The readings show that these two rules are equivalent and simply represented different ways of using the information from the three constraints that a firm faces. Much of this material is quite technical, but it is at the core of microeconomics. The unit closes with a section that shows how this theory can help critique proposals that sound good, but that are flawed because they ignore the theory developed in this unit.
After you complete this unit, you should be able to:
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