PRODUCER’S EQUILIBRIUM

LEARNING OBJECTIVES
• Who is a producer?
• Meaning of profit
• What is meant by producer’s equilibrium?
• How to determine producer’s equilibrium through
MR-MC approach in case of
i) Perfect competition (price remains constant)
ii) Imperfect competition (price falls with rise in output)
• Relationship between Price and MC at equilibrium
 WHO IS A PRODUCER?

A producer is an economic agent who produces

goods and services for sale with the objective of
maximizing the profits and minimizing the losses.

As discussed above, the main objective of any

producer is to earn maximum profits. So, now let us
discuss about profit.
 WHAT IS PROFIT?
Profit refers to the excess of receipts from the sale
of goods over the expenditure incurred on
producing them.

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.
PRODUCER’S EQUILIBRIUM
Now that we have discussed what producer and profit
are, let us come to the main topic, that is, producer’s
equilibrium.

Producer’s equilibrium refers to that price and output

combination which brings maximum profit to the
producer and profit declines as more is produced.

A firm (producer) is said to be in equilibrium when it

has no inclination to expand or to contract its output.
 METHODS OF
DETERMINATION OF
PRODUCER’S EQUILIBRIUM
There are two methods of determination of
producer’s equilibrium:

1. Total revenue and total cost approach (TR-TC

approach)
2. Marginal revenue and marginal cost approach
(MR-MC approach)
 TWO DIFFERENT SITUATIONS
FOR DETERMINATION OF
PRODUCER’S EQUILIBRIUM
A producer can attain equilibrium level under two different
situations:

(i) When price remains constant – It happens under perfect

competition. In this situation, the firm has to accept the same
price as determined by the industry. It means, any quantity can
be sold at that particular price.

(ii) When price falls with rise in output – It happens under imperfect
competition. In this situation, firm follows its own pricing policy.
However, it can increase sales only by lowering the price.
 MR-MC APPROACH

According to MR-MC approach, producer’s equilibrium

refers to that stage of output level at which –

1. MC=MR – With the aim of maximizing the total

profits, a firm compares its MR with its MC. Equilibrium
is not achieved when MC<MR, as it is possible to add to
profits by producing more. Producer is also not in
equilibrium when MC>MR because benefit is less than
cost. It means, the firm will be at equilibrium when
MC=MR.
2. MC>MR after MC=MR output level – MC=MR is a necessary
condition, but not sufficient enough to ensure equilibrium. This
is because MC=MR may occur at more than one level of output.

However, out of these, only that output level 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 output will reduce the profits, so the producer will stop
the production. On the other hand, if MC is less than MR
beyond MC=MR output, it is possible to add to profits by
producing more.

So, the first condition must be supplemented with the second

condition to attain the producer’s equilibrium.
PRODUCER’S EQUILIBRIUM
(When price remains constant)
When price remains constant, firms can sell any quantity of
output at the price fixed by the market. This means,
price=AR=MR.

Output Price TR TC MR MC Profit=

(units) TR-TC
1 12 12 13 12 13 -1
2 12 24 25 12 12 -1
3 12 36 34 12 9 2
4 12 48 42 12 8 6
5 12 60 54 12 12 6
6 12 72 68 12 14 4
Producer aims to produce that level of output at which
(i) MC=MR, and
(ii) MC>MR after MC=MR output level

According to the schedule, MC=MR condition is satisfied at both the output

levels of 2 units and 5 units. But the second condition, MC>MR after MC=MR
output level is satisfied only at 5 units of output.

According to the graph, producer’s equilibrium will be determined at OQ level

of output corresponding to point K because both the conditions are satisfied at
point K, whereas only the first condition is satisfied at point R.
 PRODUCER’S EQUILIBRIUM
(When price falls with rise in output)
When there is no fixed price and price falls with rise in output,
MR curve slopes downwards.

Output Price TR TC MR MC Profit=

(units) TR-TC
1 8 8 6 8 6 2
2 7 14 11 6 5 3
3 6 18 15 4 4 3
4 5 20 20 2 5 0
5 4 20 26 0 6 -6
Producer aims to produce that level of output at which
(i) MC=MR, and
(ii) MC>MR after MC=MR output level

According to the schedule, both the conditions are satisfied at 3 units of

output. So producer’s equilibrium is determined at 3 units of output.

According to the diagram, both the conditions are satisfied at point E,

whereas only the first condition is satisfied at point F. So, producer’s
equilibrium is determined at point E with OM level of output.
 RELATIONSHIP BETWEEN PRICE
AND MC AT EQUILIBRIUM
When price remains constant:

When price remains same at all levels of output, then price (or AR)=MR. As
equilibrium is achieved when MC=MR, it means, price is equal to MC at
the equilibrium level.

When price falls with rise in output:

When more output can be sold only by reducing the prices, then Price (or
AR)>MR. As equilibrium is achieved when MC=MR, it means, price is more
than MC at the equilibrium level.
 TEST YOUR UNDERSTANDING
1. Producer is not at equilibrium when MC>MR because:
a)Profits can be increased by producing more
b)Benefit is less than cost
c)Both (a) and (b)
d)None of these

2.In case of perfect competition, a firm is in equilibrium when:

a)MC=MR
b)MC cuts MR from below
c)MC is rising when it cuts MR
d)All of these
3.Assertion (A): A firm is at equilibrium when MR=MC and
beyond that level of output, MC must be falling.
Reason (R): MC curve should cut MR curve from below to achieve
Producer’s Equilibrium.

a)Both Assertion (A) and Reason (R) are true and Reason (R) is
the correct explanation of Assertion (A).
b)Both Assertion (A) and Reason (R) are true but Reason (R) is
not the correct explanation of Assertion (A).
c)Assertion (A) is true but Reason (R) is false.
d)Assertion (A) is false but Reason (R) is true.

4.If MC is more than MR at a particular level of output, then how

will a producer react to maximize the profits?
5.Given the following schedule, state at which level of output,
will the firm be at equilibrium and why.
Quantity (in units) Price Total cost
0 20 10
1 20 50
2 20 80
3 20 100
4 20 105
5 20 125
6 20 150
 ANSWERS
1.(b)Benefit is less than cost
2.(d)All of these
3. d)Assertion (A) is false but Reason (R) is true.

4.Producer will reduce the production to maximize the profits.

Quanti Price Total TR(Qt MR MC
5. ty cost y*Pri
ce)
0 20 10 0 - -
1 20 50 20 20 40
2 20 80 40 20 30
3 20 100 60 20 20
4 20 105 80 20 5
5 20 125 100 20 20
6 20 150 120 20 25
Producer’s equilibrium is determined at 5 units of output as at
this level of output both the conditions of firm’s equilibrium
are satisfied, i.e.,
i)MR is equal to MC (20) and,
Ii)MC is increasing at the point of equilibrium.