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Producer’s equilibrium refers to a situation, where a producer is producing that level of output, at which its profits are maximum. In other words, it is a situation of profit maximisation or cost minimisation (under MR and MC approach).
Following are the two conditions of producer’s equilibrium:
(i) MR=MC (Marginal Revenue = Marginal Cost)
(ii) MC must be rising at the point of equilibrium or MC curve must cut MR curve from below
TR – TC Approach
According to this approach, the producer’s equilibrium has two conditions:
- The difference between TR and TC is maximum
- Even if one more unit of output is produced, then the profit falls. In other words, the marginal cost becomes higher than the marginal revenue if one more unit is produced.
In the figure above, the X-axis shows the levels of output and Y-axis shows total costs and total revenues. TC is the Total Cost Curve and TR is the Total Revenue Curve. Also, P is the equilibrium point where the distance between TR and TC is maximum.
Further, you can see that before the point P’ and after the point P”, TC>TR. Therefore, the producer must produce between P’P” or M’M”. At the point P, a tangent drawn to TC is parallel to TR. In other words, at point P, the slope of TC is equal to the slope of TR. This equality is not achieved at any other point.
MR – MC Approach
The MR-MC approach is derived from the TR-TC approach. The two conditions of equilibrium under the MR-MC approach are:
- MR = MC
- MC cuts the MR curve from below
MR = MC
If one additional unit of the output is produced, then MR is the gain and MC is the cost to the producer. As long as MR is greater than MC, it is profitable to produce more. Therefore, the firm has not achieved an equilibrium level of output where the profit is maximum. This is because the firm can increase its profits by producing more.
On the other hand, if MR is less than MC, then the benefit is less than cost. Therefore, the producer is not in equilibrium either. He can reduce the production to add to his profits. When MC = MR, the benefit is equal to cost, the producer is in equilibrium provided that MC becomes greater than MR beyond this level of output.
Therefore, for producer’s equilibrium MC = MR is a necessary condition but not sufficient.
MC cuts the MR curve from below
While MC = MR is necessary for equilibrium but it is not sufficient. This is because the producer might face more than one MC = MR outputs. Out of these, only that output beyond which MC becomes greater than MR is the equilibrium output.
This is because if MC is greater than MR, then producing beyond MR = MC will reduce the profits. Also, when it is no longer possible to add profits, the maximum profit level is reached.
On the other hand, if MC is less than MR beyond the MC = MR output, then the producer can add profits by producing more. Therefore, for the producer’s equilibrium, it is important that MC = MR. Also, MC should be greater than MR if more output is produced.