MR - MC Approach
MR - MC Approach
PRODUCERS EQUILIBRIUM: MC=MR APPROACH
INTORUDUCTION
Producers equilibrium refers to the level of output of a
commodity that gives the maximum profit to the producer
of that commodity.
Profit equals total revenue less total cost.
Therefore, the output level at which total revenue less
total cost is maximum is called the equilibrium output
level.
Total revenue less total cost or TR-TC is one approach
of looking at the producers equilibrium.
You are already familiar with this approach. According to
this approach there are two conditions of producers
equilibrium:
1. TR less TC is maximum and
2. Profits fall if one more unit of output is produced
(Which means that marginal cost is higher than marginal
revenue if one more unit is produced).
MC = MR approach
MC = MR approach is another way of identifying
producers equilibrium. It is derived from the
TR TC approach. (The method of derivation is beyond
the scope of the syllabus). The two conditions of TR-TC
approach when derived in terms of MC = MR approach
become:
(i) MC = MR
(ii) MC is greater than MR after the MC = MR output
level.
Let us explain these conditions.
(i) MC = MR
When one more unit of output is produced, MR is the gain and MC is the
cost to the producer.Clearly, so long as benefit is greater than the cost, or
MR is greater than MC, it is profitable to produce more. Therefore, so long as
MR is greater than MC, the maximum profit level, or the equilibrium level is
not reached. The equilibrium is not achieved because it is possible to add to
profits by producing more.
The producer is also not in equilibrium when MR is less than MC because
benefit is less than the cost. By producing less the producer can add to his
profits.
When MC is equal to MR, the benefit is equal to cost, the producer is in
equilibrium subject to that MC becomes greater than MR beyond this level of
output.
When MC equals MR(subject to the supporting condition) the producers
profit would be less if he produces output more than or less than the MC =
MR output as explained above.
Therefore, for equilibrium to reach it is a necessary condition (but not
sufficient) that MC equals 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.
It is because the producer may face more than one MC =MR outputs.
But out of these only that output beyond which MC becomes greater
than MR is the equilibrium output. It is because if MC is greater than
MR, producing beyond MC = MR output will reduce profits. And when it
is no longer possible to add to profits the maximum profit level is
reached.
On the other hand, if MC is less than MR beyond the MC = MR output, it is
possible to add to profits by producing more. Therefore this MC = MR level is
not the equilibrium level.
For a producer to be in equilibrium it is necessary that MC equals MR as well
MC becomes greater than MR if more output is produced.
Illustrations and Graphic Presentation
Illustration I
The following illustration relates to the market, which allows the
producer to sell any quantity he can at the prevailing market price.
Note that in the above illustration MC = MR condition is satisfied both at
output level 2 units and the output level 4 units. But the second
condition MC becomes greater than MR is satisfied only at 4 units of
output. Therefore equilibrium output level is 4 units.
Graphics Presentation
When a producer is free to sell any quantity at a give price, the MR
curve is perfectly elastic
and is parallel to the X-axis. A typical MC curve is a U Shape curve.
Graphically, the two conditions of
equilibrium become:
(1) MC curve intersects MR
curve.
(2) MC curve intersects MR curve
from below.
Note that the first condition (MC = MR) is satisfied both at A and B. But the second
condition MC Curve intersects MR curve from below is satisfied only at B. After
B, MC becomes greater than MR. Then, the equilibrium output level is OQ2.
Illustration 2
This illustration relates to a market in which a producer can sell more
only by lowering the price.
In this illustration the two conditions of equilibrium are satisfied at 3
units of output. MC equals MR and MC is greater than MR when more
output is produced. The producer is in equilibrium when he produces 3
units of output.
Graphic presentation
When a producer can sell more only by lowering the price, the MR
curve is downward sloping. The typical MC curve is U-shaped.
Note that MC = MR condition is satisfied at both A and B. But the
second condition MC is greater
than MR or MC curve cuts MR from below is satisfied only at B. So,
the equilibrium level of output
in OQ2.
