Equilibrium refers to a state of rest when no change is required. Like a consumer, a producer also aims to maximize his satisfaction to attain equilibrium. But a producer’s satisfaction is maximized in terms of profits. Let us see how a producer reaches equilibrium.
Profit refers to the excess of receipts from the sale of goods over the expenditure incurred on producing them. The amount received from the sale of goods is known as revenue, and the expenditure incurred on production of such goods is known as cost. The difference between revenue and cost is known as profit. For example, if a firm sells goods for Rs. 10 crores after incurring an expenditure of Rs. 7 crores, then profit will be Rs. 3 crores.
A firm or producer is said to be in equilibrium when there is no inclination to expand or contact the production or output. In this state, the producer has either maximum profits or minimum losses. Producer’s equilibrium refers to that combination of price and output which brings maximum profit to the producer and profit declines as more is produced. Producer’s equilibrium can be determined through the Marginal Revenue and Marginal Cost Approach (MR-MC Approach).
According to MR-MC approach, producer’s equilibrium refers to the stage of that output level at which –
As long as MC is less than MR, the producer can make more profits i.e. it is profitable for the producer to go on producing more because profits will increase. He stops producing more only when MC becomes equal to MR.
We know that MR is the addition to TR from sale of one additional unit of output and MC is the addition to TC for increasing production by one unit. The aim of every producer is to maximize profits. To achieve this aim, the firm will compare its MR and MC. Profits will increase as long as MR exceeds MC and the profits will fall if MC is greater than MR. So, producer equilibrium is not achieved when MC<MR as there is scope to increase profits. The producer will also not be in equilibrium when MC>MR because the benefit is less than the cost. It means the firm will be at equilibrium when MC=MR.
2. MC is greater than MR after MR=MC output level
When MC is greater than MR after equilibrium it means producing more will lead to decline in profits. MC=MR is a necessary condition but it is not sufficient to ensure producer equilibrium. This is because MC=MR may occur in more than one level of output. However, out of these, only that level of output is the equilibrium output when MC becomes greater than MR after the equilibrium. It is because if MC is greater than MR, then producing beyond MC-MR will reduce profits. But, if MC is less than MR, then producing beyond MC=MR will be profitable. Therefore, the first condition must be supplemented with the second condition to attain producer’s equilibrium.
In the figure given above, output is shown on the x-axis and revenue and costs on the y-axis. Both AR and MR curves are straight line parallel to the x-axis. MC curve is u-shaped. Producer’s equilibrium will be determined at OQ level of output corresponding to point K because only at point K, both the conditions are met.
Although MR-MC is satisfied at point R, it is not the point of equilibrium since the second condition, that MC be greater than MR after MC=MR, is not satisfied.