Classical Foundations

Abstract

The purpose of this chapter is to review several important ideas in economics. The firm operates in and is disciplined by markets, so we begin with the economist’s notions of a market and market value. Present value of a stream of future cash flows is interpreted as a market value in this context. Next we review the economist’s portrayal of a firm as an institution that straddles factor and output markets. In this view, the firm uses market prices and its production function to decide what to produce and sell, and how to produce what it has chosen to produce. This characterization allows us to identify the firm’s cost curve and to represent its output decision using the familiar (and dreaded) marginal revenue equals marginal cost calculation. We then extend this review to encompass firms that operate in imperfect markets and multiproduct firms.