Firm behavior

The objective of firms is to maximize profits while avoiding illiquidity. Hence, unlike households, the firms in this model do not act on the basis of a preference set but instead strive to position themselves optimally within a system of constraints. The physical constraints that each firm has to respect are given by the production function. This function prescribes that output is the result of the combination of input factors and that only capital investments can increase a firm’s productivity. Furthermore, the balance sheet of a firm and the corresponding accounting rules represent the financial constraints. The most relevant magnitude in this context is a firm’s liquidity position. Finally, the economic constraints that a firm is confronted with are the factor prices and the demand for its products that it finds in the markets.