Equilibrium
Conditions for a Firm
Equilibrium
of the firm means that the firm reaches the maximum profit. Now, there are two
approaches (TC = TR) for calculating the maximum profits
Total curve
approach; and, ii. Marginal curve approach (MC = MR)
In the
TC-TR Approach, profit is obtained by a firm, through the difference between
the TC and the TR. Equilibrium is obtained at the point where maximum
difference between the TC and TR occurs. This TC-TR method is not generally
adopted in the calculation of maximum profit. Hence to calculate profit / loss,
economists resort to the MC=MR approach. Shaded area denotes profit. Profit is
maximum when Q = 5
In this
approach, the following two conditions are to be verified to obtain equilibrium
of a firm.
Look at
the following hypothetical situation. A rational seller will not be in
equilibrium at output level 1, though MC=MR at that point, since continuing
production, his profit increases. When he produces an output beyond 1 unit till
he reaches 5 units, his MC < MR. It is advantageous for the producer to
continue his production.
Again, he
will not be in equilibrium beyond 5 units of Q, when his MC > MR, implying
that the seller incurs loss.
Therefore,
he is said to be in equilibrium, i.e., at the point of maximum profit when his
MC is equal to MR. Hence, MC = MR is the first condition for the equilibrium.
(Note: This is a necessary condition but not a sufficient condition).
A firm
under perfect competition faces a horizontal price line. (It is also the AR
curve and the MR curve). A firm under imperfect competition focuses declining
price line. The MC is U-shaped and it cuts MR at two points, both from above (i.e., at point A) and also from below (i.e., at point B), as shown
in the diagram.
Only at
point B, the equilibrium condition is fulfilled. Thus for equilibrium under all
market situations the two conditions viz., MC = MR; and MC cuts MR from below.
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