- It is a situation in which a firm produces that level of output that maximises its profits. When the total profit of a firm is maximum then it is said to be in equilibrium.
- A firm’s Total profit is defined as TR -TC. When the positive vertical difference between TR and TC is maximum, the firm is in equilibrium.
We will try to understand this via MR–MC Approach
MC – Marginal Cost
The increase or decrease in the total cost of a production run for making one additional unit of an item.
It is computed in situations where the breakeven point has been reached: the fixed costs have already been absorbed by the already produced items and only the direct (variable) costs have to be accounted for.
Marginal costs are variable costs consisting of labour and material costs, plus an estimated portion of fixed costs (such as administration overheads and selling expenses).
In companies where average costs are fairly constant, marginal cost is usually equal to average cost. However, in industries that require heavy capital investment (automobile plants, airlines, mines) and has high average costs.
it is comparatively very low. The concept of marginal cost is critically important in resource allocation.
Because, for optimum results, management must concentrate its resources where the excess of marginal revenue over the marginal cost is maximum. Also called choice cost, differential cost, or incremental cost.
MR – Marginal Revenue
Marginal revenue (Increase in the gross revenue of a firm produced by selling one additional unit of output.
MR – MC APPROACH
MR-MC approach in general a firm’s profit-maximizing condition is MR = MC.
But for a competitive firm P = MC (Because perfect competition P = AR = MR and MC are rising – Competitive firm chooses its level of output in the rising portion of MC curve.)
There are two conditions of Producer’s Equilibrium
MR = MC
When one more unit of output is produced, MR is the gain and MC is the cost to the producer, so as long as the benefit is greater than the cost or MR is greater than MC.
It is profitable to produce more. The producer is not in equilibrium when MR is less than MC because the benefit is less than the cost. By producing less the producer can add his profits.
MC is greater than MR after the MR=MC output level
It because if MC is greater than MR, producing beyond MC=MR output will reduce profits.
In the above diagram producer’s equilibrium in IMPERFECT
In this diagram point E shows MR=MC, so the producer will be in equilibrium on point E i.e. output level 4.
Because point E satisfies both the conditions required for equilibrium i.e. MR=MC and MC > MR after equilibrium output.
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