Note on Equilibrium of Firm (MR-MC approach)

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CONCEPT OF MARKET
Generally, market is known as the place where goods and services are purchased and sold. But, in Economics, market is the contact between the buyer and seller for buying and selling of the goods at the given price.

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EQUILIBRIUM OF FIRM

A firm is said to be in equilibrium when it maximized its profit. It is also called as the difference between Total Revenue (TR) and Total Cost (TC). The firm gives various outputs; sometimes it gives low and sometimes it gives the high output which provides lower profit to firm. When the situation is of nor high nor low i.e. equilibrium is obtained and it gives more profit.

Once the firm attained equilibrium, the firm doesn’t have the incentive to change its price and output because profit is already maximized.

According to Hanson, “A firms will be in equilibrium when it has no advantage to increase or decrease its output.”

The firm equilibrium is explained with the help of two approaches they are as follows:

  1. Marginal Revenue and Marginal Cost approach (MR-MC approach)
  2. Total Revenue and Total cost approach (TR-TC approach)

Marginal Revenue and Marginal Cost Approach (MR-MC approach)

According to this approach, the firm is said to be in equilibrium if the following conditions are fulfilled:

  1. Marginal cost is equal to Marginal Revenue i.e. ( MC = MR )
  2. Marginal cost (MC) Cuts Marginal Revenue (MR) from Below.
  3. Marginal cost (MC) Cuts Average Cost (AC) from the Minimum point.

These three conditions are also known as sufficient conditions. If these conditions are fulfilled the firm is said to be in equilibrium i.e. Maximized profit, which is clearly shown in the figure below.

Equilibrium of Firm
In the above figure, X -axis represents the output and Y -axis represents the Price cost. OP is the price. Since under the perfect competition AR is equal to MR. AR and MR curves are horizontal from P. Hence, ‘MR’ Marginal Revenue curve and ‘MC’ Marginal Cost Curve intersect each other at point E, which is known as Equilibrium point. OQ units of output are produced in a firm, thus OQ is the Equilibrium Output. So, The profit maximizing output is OQ. The firm earned supernormal and abnormal profit equal area PABE. If the output is less than OQ and to obtain the maximum profit, the output should be increased to OQ. The firm can maximize its profit up to MR is greater than MC i.e.MR > MC. Profit is possible only until MR is equal to MC i.e. MR = MC. If MC becomes greater than MR then Firm level of output bear losses.

Equilibrium of Industry

In Economics, Industry is the group of a firm producing homogeneous product or commodity. In the perfect competition market the must be fulfilled for an industry to be in equilibrium they are:

  1. Quantity demand equal to Quantity supply i.e. (QD = QS)
  2. Marginal cost (MC) Equal to Marginal Revenue (MR) e. (MC = MR) and Marginal cost (MC) cuts Marginal Revenue (MR) from below.
  • There should be no tendency on the part of the firm to enter or leave the industry.

It is clearly shown in the figure below:

Fig(ii)

In the above figure (A), SS is the supply curve and DD is a demand curve and AR and MR is equal. An industry is in equilibrium at the point “E”. OP is the equilibrium price and OQ is the equilibrium Quantity output. The industry gets equilibrium at price OP, where demand and supplies are equal. The firm is in equilibrium by making MC = MR and MC cuts MR below at the point E. So that it is called firm equilibrium. The firm earned an abnormal profit equal to area P1EBA. But it should be noticed that if the firm earned supernormal profit or loss, it is only short-run equilibrium hence, the third condition for equilibrium can be only realized in a long run.

(Karna, Khanal, and Chaulagain)(Khanal, Khatiwada, and Thapa)(Jha, Bhusal, and Bista)

Bibliography

Jha, P.K., et al. Economics II. Kalimati, Kathmandu: Dreamland Publication, 2011.

Karna, Dr.Surendra Labh, Bhawani Prasad Khanal and Neelam Prasad Chaulagain. Economics. Kathmandu: Jupiter Publisher and Distributors Pvt. Ltd, 2070.

Khanal, Dr. Rajesh Keshar, et al. Economics II. Kathmandu: Januka Publication Pvt. Ltd., 2013.

  1. Equilibrium of firms gives more profit.
  2. A firms will be in equilibrium, when it has no advantage to increase or decrease its output.
  3.  Profit is possible only until MR is equal to MC i.e. MR = MC
  4.  MC becomes greater than MR then Firm level of output bear losses.
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what is perfect competition? how are price and output determinent under it?


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