ABSTRACT
This chapter discusses F. H. Knight’s analysis of the single variable-factor case, and elaborate it by making explicit some implicit assumptions about production functions, by clarifying the role of externalities in the model, and by suggesting an appropriate theory of the firm. The analysis of free-access resources can pose some awkward problems in specifying the quantity of the resource used by the firms operating it. Free-access resources may be over- or under-exploited, and accordingly, increasing-cost industries may be over- or under-expanded. The behavioural hypothesis must be consistent with the technological assumptions, and should conform with traditional theory. In standard competitive theory, the firm takes the price of the product as a parameter determined by market demand and supply on which its own influence is negligible. The comparison between equilibrium and socially optimal factor quantities can be analysed in terms of a “substitution” effect and an “output” effect.
