Producer’s Equilibrium

 Producer’s equilibrium: Producer is said to be in equilibrium when with the given demand & cost conditions,
it produces that level of output at which profit is maximum.

 Pure Profit (super normal profit): it is excess of revenue over cost. [symbol of profit = π]

 π = TR – TC

 Normal profit: it is a minimum return that a producer expect for the risk undertaken. Firm will earn normal
profit when TR = TC or AR = AC, it is a situation of break point where firm is able to cover its cost.
 Normal profit is a situation of no profit no loss.
 They are part of total cost

 Shut down is the level of output where firm is able to cover its variable cost only, so it is that level of output
where AR = AVC.

 firm may or may not stop it’s production at this level of output, so it is that level of output though firm is
incurring losses yet they will continue production because even if they stop their production the amount of
loss will remain same. But below this level of output producer will stop its production so at this level of
output firm incur the maximum losses which is equal to its fixed cost.

 If AR < AVC then firm will stop its production because in this case it is not able to cover its variable cost
hence losses are more than its fixed cost.

 Minimum condition to continue production in short run is AR ≥ AVC

 Maximum loss that a firm can incur is equal to its fixed cost.

 MR – MC approach

 Under MR – MC approach there are three conditions for producer’s equilibrium.

1) MR = MC
2) MC must be rising. (MC must cut MR from below)
3) AR ≥ AVC it’s a third condition which we will assume that it is being fulfilled.

Y
C
V
C MC
Cost

B E
V
C C MR
V V
O QC CQ1 X
C CV VCV C
V Output V
V CV
 At
C Point C MC is falling, thus producer will not attain equilibrium.
C B, though MR = MC but
V V is increased beyondVOQ level of output MR > MC, it means total profit will increase. so by
 If output
producing more producer can maximise his profit so beyond OQ profit will increase hence it cannot be the
point of equilibrium.
  If Producer produces any output beyond OQ1 its profit will fall as MC > MR so producer cannot go beyond
OQ1.

 Similarly at any output less than OQ1, MR > MC which mean profits can be increased by increasing output
toward OQ1.

 At OQ1 level of output, MR = MC & MC is rising, (MC must cut MR from below) therefore producer attains
equilibrium when they produce OQ1 level of output as at this level producer earns maximum profit. Change
in output at any direction would reduce profit.

Output MR MC Per unit profit TR TC Total Profit

1 6 8 (2) 6 8 (2)
2 6 6 0 12 14 (2)
3 6 4 2 18 18 0
4 6 2 4 24 20 4
5 6 5 1 30 24 6
6 6 6 0 36 30 6
7 6 8 (2) 42 39 4

Conditions for producer equilibrium in long run.

1) MR = MC
2) MC must be rising. (MC must cut MR from below)
3) AR ≥ AC it’s a third condition which we will assume that it is being fulfilled.