The basic model

Abstract

In this chapter, a disequilibrium model of the behaviour of the firm is developed. As in the models of the New Keynesian Macroeconomics, the fix-price method is applied, because quantity constraints are considered as more important for the business cycle than endogenous wage and price setting. In contrast to these models of general (dis)-equilibrium, however, the analysis is limited to the firm’s decisions in disequilibrium situations. Household behaviour is left outside of the analysis, and only the partial (i.e. firm’s) equilibrium is derived within the model. The main features of the model are dynamic factor input adjustments and an explicit aggregation over firms in different goods and labour market situations. Within this framework, the optimal decisions of the firm with respect to output, employment, investment, and capital-labour substitution are derived from microeconomic optimization behaviour.