Posted by Anjali Kaur on Oct 03, 2020
Producer Equilibrium

Producer Equilibrium

A producer is said to be in equilibrium when he produces that level of output at which his profits are maximum. There are 2 methods of determining producer equilibrium:

  1. TR-TC approach
  2. MR-MC approach

In this post, we will learn only the MR-MC approach in detail.  Let’s learn

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Profit Maximization

Producer equilibrium is also known as profit maximization situation.

Profit = Total Revenue – Total Cost

or

Profit = Marginal Revenue – Marginal Cost

Conditions of Producer Equilibrium

There are 2 main cases of producer equilibrium:

  1. When prices are constant.
  2. When prices fall with the rise in output.

Let’s discuss these cases.

1. When prices are constant – Perfect Competition

When prices are constant, producer equilibrium is determined when the following 2 conditions are met:

  1. MR = MC
  2. MC must be rising, after that point.

So, the producer will keep on producing more output until the above 2 conditions are met.

Let’s make an MR- MC table:

OutputMRMC
1810
288
387
4*8*8*
589

According to this table, producer’s equilibrium condition is satisfied at 4 level of output, where MR = MC is 8 and MC is rising after that.

Why?

Well, according to profits, producer will reach its break-even point when MR = MC and if MC is rising after that, it implies cost to producer becomes more than the revenue. Hence, both the conditions must hold to achieve producer equilibrium.

As shown below:

According to the diagram, although MR = MC at 2 levels of output; L1 and L2. But, producer equilibrium is achieved at L2 level, because MC rising after that.

2.When prices fall with the rise in output – Imperfect Competition

When prices are falling, producer equilibrium is determined when following 2 conditions are met:

  1. MR = MC, (MR curve should be sloping downward).
  2. MC must be rising, after that point.

So, the producer will keep on producing more output until the above 2 conditions are met.

Let’s make an MR- MC table:

OutputMRMC
1109
297
386
4*7*7*
568

Here, the producer will reach at equilibrium at output level of 4, where MR= MC & MC is rising after that.

In the above diagram, producer will reach equilibrium at point Q*.

Thank You!

You can read the related concepts:

  1. The price elasticity of supply
  2. The supply curve
  3. What is production function?
  4. Terms related to production concept
  5. Law of diminishing returns to a factor
  6. Total cost, Total variable cost and Total fixed cost
  7. The relation between TC, TVC and TFC
  8. Average total cost
  9. The demand curve

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