18.

Explain the conditions of a producer’s equilibrium in terms of marginal cost and marginal revenue. Use diagram.

Equilibrium refers to a state of rest when no change is required. A firm (producer) is said to be in equilibrium when it has no inclination to expand or to contract its output. This state either reflects maximum profits or minimum losses.

There are two methods for 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): According to MR-MC approach, producer’s equilibrium refers to stage of that output level at which:
1. MC = MR:
As long as MC is less than MR, it is profitable for the producer to go on producing more because it adds to its profits. He stops producing more only when MC becomes equal to MR.

2. MC is greater than MR after MC = MR output level:
When MC is greater than MR after equilibrium, it means producing more will lead to decline in profits.

Both the conditions are needed for Producer’s Equilibrium:

1. MC = MR: MR is the addition to TR from sale of one more unit of output and MC is addition to TC for increasing production by one unit. Every producer aims to maximize the total profits. For this, a firm compares it’s MR with its MC. Profits will increase as long as MR exceeds MC and profits will fall if MR is less than MC. So, 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 the cost. It means the firm will be at equilibrium when MC = MR.

2. MC is greater than MR after MC = MR output level: MC = MR is a necessary condition, but not sufficient enough to ensure equilibrium. 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 profits. 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, first condition must be supplemented with the second condition to attain the producer’s equilibrium.