1·

~ oDUCER'S EQUILIBRIUM

.V/10 1, cl Produccr 7
conccpt of Producer's Equil1briurn \
(ond1t1on, of Producer's Equ1 l1brium
Tabular and D1agr amma t1 c Pres en tation of
Producer's Equ1l1brium

J 1. WHO ISA PRODUCER?

I , 11 1\ I)

He , uppli c, thc, e good, and serv ices in th e mark et to ea rn BRAIN JIJa.

;:i~c,:nc hi' \1 Jy of profi t. TEASER ~
Read the st atement
,:;,J I Produc11on requ ire, input ,: (1) l,1 cto r input s, and (ii ) no n-fac tor input s.
given below Htl In the
S,pc1d1ture incurred oy the prod ucer on th ese inputs leads to cost blank using t he correct
option:
01prc,dumo n. On th e other h:rnJ , s,de of goods and services by th e
"A fi rm strikes its
~:,,cum leads to re\'('11 Ue. equilibrium when its
profit rs max1m1sed.
This state of equilibrium
Is achieved when the
'X'he n thi , differcncl' 1, mJx imi scd, profit is also maximised.
chfference between Total
Revenue and _ __ I~
f, pn,ducn undert ak es produ ction wi th a view to max imi sing hi s profit. maximised."

H,· ;cl11c·vc·~h1 ~goal by maxi 111 i, 1ng the difference betwee n revenue and cost. (a) Total Explicit Cost of
Production
(b) Total of both Explicit
Cost ancf lrnpl1Cll Co~t or
2. CONCEPT OF PRODU CER'S EQUILIBRIUM PrOductlon
Ans. (b) Total of bOlh
Explicit Co~t Jnd
i ;.:•,~·, ,,., '. tr ik(:, hi \ equ il ilni um Jt th at level o( omput where protit lmpliCI! Co~l of
Proctucuon
, :·.rmw,•:d. /\ r1y r>ther k vel uf outpu t (oth er than the equilibrium
';<;1;iu11
·11,,uJd 11 11 . . . . )
1 h,i111 :,1 n l<, wu pro fit (l ower th an the maxrmum .
i1 v;:n,•1;, I) · I I
· Yl a< 11 al!·d :r'. tlw dll. le. rence between 1 .Ram1·1·c' .

~ il11·rl', n "' Profit

rl< ~ Total l'L'V\'lllll'
TC - Total r<"t.
 , equilibrium is struck at that level of outp
produ~s •wh
· · ed•
maxmus er, ~.

Profit 1s. manm1se

. . ( dth roducer strikes his equilibrium) when the difference betw
d an e P .een l'~
"
TC is maximised. ~

Economic Profits and Accounting Profits

B th economic profit and accounting profit are estimated as th .
o h . . .fi e d1ft
between TR and TC. Yet, t ere 1s a s1gn_1 cant difference hetweerenc,
two concepts, whereas accountants_ consider only explicit costs ~n the
·mation of TC), economists consider both explicit as Well .(in the
es t1 as Ill} .
costs. Thus, ---------~---.. 1
Ptcit
Economic Profits = TR - TC J
(Here, TC includes both explicit cost and implicit cost)

Accounting Profits = TR - TC J
(Here, TC includes only explicit cost)
Or

Economic Profits= TR - (Explicit Costs+ Implicit Costs)

Accounting Profits= TR - Explicit Costs

In economics (and in the entire discussion that follows), we are focusin

only on economic profits. g

Gross and Net Profit

Economic profits are estimated both as gross profits and net profits. The
difference is as under:

Gross Profit = TR - TVC

Here, TR = Total revenue
Net Profit = TR - (TVC + TFC) TVC = Total variablecost
=TR-T C TFC = Total fixed cost.

Gross profit refers to the difference between TR and TVC.

Net profit refers to the difference between TR and TC.

Abnormal Profits, Normal Profits and

Sub-normal Profits
In economics, performance of a business is assessed with reference to
three levels of pr0 fit · · (·)
(
.. . s, vzz., 1 abnormal profits, (ii) norm al profits' and
m) sub-normal p fi D .
ro ts. eta11s are as under:
 rrocl11r ('J ', ('(jl!llilJ Jll/rJl

profits (or Ex tr2-n orn1al Profits)

rr.1;1 I
1
al profits when:
\":1' arns abnorm
··
.~r"
.,.w~-er e I TR> TC w, TR
wek now --AR'
'Q -
Or
TC
~ Q=A C.

~
Or

AR> AC

. mal profits
,or
· fits are earned when:
Noflll~ pro .-- --- -.
I TR=TC
Or

I~~ ~c I
Or

AR= AC

t ,uh-normal Profits (or Lo "'~ J

Aproducer earns sub-normal profits (or incurs losses) when:

I TR<T C I
Or

~ Or

AR <AC

s from his
Normal profits aredefined as the minimum return that the producer expect
· ·tl
· · . • ·
caprta[ invested in
Vlitl'd the business. If this minimum return 1s not available, he w1 FOCUS ~
'!~aw his capital from the existing use and shift it to some different use. Norma
l ZONE ~ j
are apart of TC. I \
 3. CONDITIONS OF PRODUCER'S EQUILIB
A producer strikes his equilibrium (and maximises his ~llJ~
........
....... Mows:
. d' . . fi
followmg con 1t1ons are satls e :d
(i) l\1R (1mrginJ I rcwnuc) = MC (m;1rginal co.\!),
Profit) "'h'" 'lit

•--IDnO•- -
llll!Sllllln MR. lt ls
(ii) l\1C should be rising when MR= MC, and
pralltable for the proclKer
(iii) AR (price)~ AVC (average variable cost).
rogo on procla,g more
because it adds to t'is/her It is only when these conditions are satisfied that the diti
pro11s.·
. . . d . I . th . . . crence bctw
Ans.MC. TR d Tc an 1s max1m1se , imp ymg e max1m1sat1on of profit. ecn

In order to maximise profit, a producer should choose the output for which MR is equal to M
MC must be rising at the equilibrium level of output. Also, AR (price) should at least be equ· Cand
(average variable cost). a1to AVc

4. TABULAR AND DIAGRAMMATIC PRESENTATION

OF PRODUCER'S EQUILIBRIUM
Tabular Presentation
Table l illustrates how a producer strikes his equilibriu m, by maxiinising
his profit.

Table 1. Producer's Equilibrium [MR, MC Approach]

Note
- ~: <: 1is drawn on the
assumption that the
(Units ofOutput)
Q ·
';/,-''
I :~ ~ ']'i"•
>'
, ·
MK
-
,. 1• MC
(~
product price is constant
for a firm, as under
12 15
?- ~ ... ,.. . . . . . . . IC':-...,

perfect competition. It
is assumed to be~ 12 per
2 12 12
.,; •. . ; - 1.-..;1o;~>ll4'>'... ~ .,.,.. ,,,_

unit Constant AR implies

constant MR = ~ 12. 3 12 10
MC is shown as initially
falling and subsequently 4 12 9
rising. This is in
accordance with the law 5 12 8
of variable proportions.
Falling MC is due to 6 12 7
increasing returns. Rising
MC is due to diminishing 7
returns, 12 8
8 12 9
9 12

]I
12 15
 \ ,',-,ti00s~\R ,. MC in two sit_uations: (i) when 2 units of output
l .. .. <' 1. d ('i) when 10 umts of output are produced. However
1
~· I' ·J
I ,~f\ Ul . ~- aJl (when output= 2 umts· ) MC 1s · 1a
r 11·mg, in situation 2'
1
1ri t . i!11at1on . ..
-~ile1flS 10 units) MC 1s nsrng.
•·
,,~en°utpllt "'. . r rl1ducer will ~tnk~ Im eq uilibrium only when
1
~ earlier, ·
\i 001 . p\vino that the equilibrium will be struck when 10
,·, 1:l~- 1
,.:: ·, ••· · n1re produced,
'. o
I. .
not when 2 units of output are produced
'... . ioocpot a . .
'\ ;;!\1rs 0 . le Given the pnce, falling MC only increases the.
i,i~0 is bs101P,een· TR and TVC (recall, LMC = TVC, and LMR =
. ce et\\
~ueren that TR_ TVC tends to rise, or that profits tend to rise in a
;~ TRl-~o offa1ling MC. Accordingly, it would be an irrational decision
' ~{llaoon d cer to strike his equilibrium in a situation of falling MC .
.ra pro uwhen MC is rising that a producer would strike his
10 .
It 1s on 1Y
equilibrium·
·~f.i equilibrium will be struck when MR = MC = 12, and MC is
, I fbus,
. . The producer will maximise profits when 10 units of output are
nsing.
produced.
Let us illustrate this point furth er with reference to Tabk· I. Table 1
"'-...; offers us rwo clifferent situations when MR = MC, as under:
Situation 1: When output = 2 (and MR = MC, and MC is falling)

TR= LM R
= 12 + 12
= 24
TVC = LMC
= 15 + 12
= 27
rr = TR - TVC (Here, n refers to gross profit.)
= 24 - 27
= -3
Situation 2·· Wh en output = 10 (and MR = MC, and MC 1
.s ns111g)
..

TR = LMR
= 12 + 12 + 12 + 12 + 12 + 12 + 12 + 12 + 12 + 12
= 120
TVC =IMC
= 15 + 12 + 10 + 9 + 8 + 7 + 8 + 9 + 10 + 12
= 100
 1t = TR - TVC (Here, 7t refers t
= 120 - 100 °
gross Pro5
t)
=20

Observations
■ We find that the ditference between TR and
TVc
. . dc .
output 1s mcrease ,rom 2 to .10. In fact, 1t is only Wen htends to rise
. maximum. output ,.
,as
units that the profi t (n) 1s
10
10 units , will reduc e Th .
■ If output is increased beyond 7r
· Us,h1f 1J Un1ts , r
.
output are produced, IMR = 132, while IMC== 11S I SO t at 0
when OUtp 7t"' Ta,
TVC =132 - 115 = 17 (which is less than 20 Ut:::: 10).
■ The third cond ition that AR (price) ~ AVC (average .
Variable cost)
should also be satisfied. Because, no. producer would ever Unde
. . . ~e
production 1f the pnce 1s not covenng the variable cost per unu of
output.

a producer will reach the .

It is only when MR = MC, and when MC is rising that point ot
where profit is maximised. Also, AR should at least be equal to AVC.
equilibrium,

Diagrammatic Presentation
brium.
Fig. 1shows diagrammatic illustration of producer's equili
Producer's Equilibrium [MR, MC Approach]

I ..,
u
"'
0
y
MC

-a P 1--+ -- - -- --j lf- - AR = MR

C
Ill
QJ
::,
C
QJ
>
QJ
ct'.

Output
lNote: Is drawn on the assumption that AR is j
.
rconstant for a firm and is equal to OP. It is as in a I
uatlon of perfect competition. Constant AR implies · ~
constant MR. Accordlngly, AR =MR, and both are j
~~--~~~~~-~U!!1~~~~~~j
 I'• , 1:

r,•ations
..• 1, ,\R is assu.med to be constant as
under perfect comp et't'1 10n.
tlti-\1' l·n.•
111 • • AR implies constant MR Thus 1 both AR n a d MR are
,
•,Jl,1.,111 . ·
l • . · _,,1 by a horizontal stra
ight line parallel to X-axi·s • MC cuI ve IS
. ,J 1(.ttt'U
to be U-shapcd, as usual.
\i\~'
10
,ho"11
· .. .,qua1 to MC in two situations:
• MR I~'
·) ,t,int Q ,vhen out put = OL11 and
1
(1 .I11
··) , ,int Q,- when out put = OL2.
(II ,I11 l
g. Equilibrium
MC is risin
In situation 1, MC i_s falling but in situ~tion 2,
when: (i) MR = MC, and
of the producer will be struck at pomt Q2
1

(ii) MC is rising.
point Qt.
the
It is at point Q2_that _ profit (= T~ - TV~) is _maximised, not at
c ·t, Q2 is a s1tuat10n of profit
while Q1 1s a situation ofloss • This is how
In,ac
we can prove it.
\'i'eknow,
a given level of output
TR= Area under MR corresponding to

This is equal to OL 1QiP in situation 1.

Likewise,

TVC = Area under MC correspondin

g to a given level of output
~rit.
This is equal to OL,QiR in situation I.
Evidently,
It is asituation of loss to the firm . In such
a situation, it would not be wise
ticularly when, by increasing
for the producer to strike his equilibrium (par
the output, he can wip e out the losses).
rising at point Q2, we find that:
Corresponding to situation 2, when MC is
TR = OL2QzP, and
TVC = OL 2Q2R
Evidently, TR > TV C
· h d ·11
. d.1cates the existence of profit. Accordmgly, t e pro ucer
1 Th·1 111
~
WI

2 when: (i) MR = MC, and

s'._rike his equilibrium only in situation
nt must at least be equal to
(n) MC is rising. Also, price (AR) at this poi
tion is not possible, unless
average variable cost (AVC). Because, produc
at least van·a ble costs are covered.
.
1 1 nt
; th reference to Fig. I,
producer's equilibrium is struck at poi
: (i) MR = MC, a nd
2
When output = OL • It is here only that
2
 (iil ~1C is risi:i.g. Also, AR~ AVC. [AVC curve is not drawn t
diagram simple. Students are advised to check Ability Zo O keep th
ne for f e
clarification.] Utth,1

EXAMPLES
Example 1.
The table below contains data which represents the cost and re\>
of
s1tua on a firm · Analyse the data given below and ans'\\terenu,
• tt'
h 1
questions that follow: t '

Output (Units) 2 3 4

8 7 6 5
Pricem
6 II 15 20
26

Calculate profit at each level of output. Also, find that level of output h
w ere
profits are maximised?
Solution:
Output Price Total Total MR MC
:r
m Cost Revenue (TR,, - Tlu_J (TC0 - TC0 _1)
(Units)
m (Price x
Output)
m m ~,
(TR - Tq

(()
~U'
8 6 8 6 2
¢
2 7 II 14 6 5 3 ;:a
3 6 15 18 4 4 3 l;a3
4 5 20 20 2 5 0 ~(
5 4 26 20 0 6 -6

At output levels 2nd and 3rd unit, the difference between TR and TC,
ie., profit is maximum, which is equal to 3 in both the cases. But the
producer is in equilibrium at 3rd unit only where MR = MC (= 4), and
MC is rising.
Example 2.
Estimate producer's equilibrium using MR-MC approach from the
data given below:
Output (Units) 2 3 4 5
AR (t) 20 18 16 14 12
AC(~)
20 12 12 14 16
 :o za
'I

••,.
I
I tZ
.
.¼ 24

3'
16

1l

J
I

-tI
•j
1l
t~

16
So
(fJ
56

so
8

4
20

24

~ ; _ --~ut the producer is in equilibrium as all condin· f

. c,: o~•r ' ons o
.• : -::,,--"-:5
,., ,
,,-....;
_,,.,.,,.. , ...e ~ .,...5
;ied. Tbus,
,,,,,,,.,,,,,.-_.,,., '-'
!:!-"-~ , •C a.t rte paint of equilibrium
\'-<- :::, _-.
: ;,~ ~ rs.c.gct the Point of equilibrium (or MC >MR after the point
/ •• - _ _:,:1,:j "J.:Il)
~-·· ~re
,,,; ,,,,. ~
a.t the point of equilibrium (in the above table
. l :t. ? ••
:;, ~=- e,?0::1cing to the point of equilibrium, AR>AC which implies,
.0l
~ roust be greater than AVC, as AC is always greater than AVC.)

1]:atllappens cvhen a unit more or a unit less is

,..~uced t~a!: c:.. 2 ::nits of output?
,,,.
:_::;,er is tbzt in both the situations ;: will be !ess compared to the
·_ ,·:,~- ·::':-: r;-..__ _ ·..::-.::·, r_,_ r~·-,r,~·~ "",..e ?~educed. Figs. 2 and 3 illustrate

:::,,::uation.
1ncaseOL units of output are produced (as in Fig. 2):
3

..,
.,,,
u
0
y
w· e . output is beyond
the p0·nt of equilibrium
MC
I
v,-
~ p t---looii_ _ _ _ _ __ _,,.....,.._ AR= MR
r,;

,-
11)
>
II)
c.c.

0
~ - -- - - - -- -.1.--..1...---X
~ ~Output

Addition to TR = Area L2L3TQ2

Addition to T VC = Area L 2L3Q 3Q 2
 .
:\dditilm to T\'C is gre.1trr th.in addit ion to TR · Add'Jtio aJ ·
n lvc e S
additional TR by the area ~TQ3•
So that TR - T\'C will tend to shrin k.
~c~ ~
~-
In case OL, units ofoutput are produced (as in Fig. 3~
Y When output is reduced below
~
the point of equmb,;um Mc ~ ,

J~j
I. ~
t~
~j
L- --- --- ~L ~~ L- -.X
~
~
O Output
l 2

( Alea L1L2~0,• (loss oflll) > Alea L,Lll2T(gain ofTVC) J

-~ • •
t

,I

TR reduces by the area L1L2Q2Q1 !~jlil

TVC reduces by the area L1L2Q2T f~ing
I,oo
Or' •Le loss Of TR
Thus I reduction in TVC is Jess than the reduction in TR. Ul
jlircr
is greater than the gain of TVC. ,i{Ul{iC
#nl
Accordingly, TR- TVC will tend to shrink.
iflll lf
n MR = MC, and
Thus, any departure from the state of equilibrium (whe
l
een TR and TVC }fha_
MC is rising) would only mean that the difference betw l~ Jgt
k, or that the profits will not be maximised .
will tend to shrin ~UJlll
OU
kW

1' TEST YOUR UNDERSTANDING

)Jhtn
Or, ili:

Q. Fill in the blanks with appropriate words: 11\lcl

(i) If MR is greater than MC, output should be _
_ _ __ , lisi it
ds _ _ __ _
(ii) Profits of a firm diminish when _ _ _ _ _ excee IJUIBI
of the fi rm should be rising.
(iii) At the stage ofproducer's equilibrium, _ _ _ _ _ ilPri
(iv) _ _ _ _ _ refers to excess of revenue over cost. ,! Why
(v) When more output is sold by reducing the prices,
AR _ _ _ __ MR. '10(!1
t, price MC.
(vi) When price remains constant at all levels of outpu &lhisi
>, (vi) =.
Ans. (i) increased, (ii) MC; MR, (iii) MC, (iv) Profit, (v) uwo

C
 ale of the Conditions of Producer's EqulUbrtum
Ration
FOCUS ~
. t t-1
R:= MC
re not equa~ It would mean there Is a scope for the firm to
ZONE
t,4R ,,,d r.4C ~e between TR and TC. Implying that there Is a scope to Increase '
c'-" ... differeo
',.,st''"'
f'~.11¢: R, MC, additional unit of output le~ds to greater additional revenue than the additional cost of
f· ,ase t.4 increasing output, profit would nse.
111 10 .rr,on. BY
predl)\,' < MC, additional unit· Of out put lead5 to greater additional cost than the additional revenue. By
,ase t.4R profit would increase.
1111 10 in9 output. .
ciJI! h point of Equilibrium, MC should be rising
. 2: At t e . . . .
.i1n1on . . (but falling) at the point of equilibrium, the firm should be enjoying increasing returns to a
,,,. t rising · · (MP 1 · · · · ·
!AC iS no . output when returns are r~sing . s increasing or MC 1s falling) would amount to foregoing/
t .., StoPP'ng . h the firm can earn by increasing the output. · .
~1"'· fits wh1c
iosif19Pro . t the point of Equilibrium, AR~ AVC
•....t:tiOO 3. A. not able to cover even h'1s vana
LO'"''' . e cost, .1t would be totally irrational to undertake production
. bl
.•Aucer 1s ·
t~P~ .

WhY should MC be rising at the point of equilibrium?

QL Or
Equilibrium is never struck in a situation of falling MC. Why?
~ falling MC means that the cost of producing an additional unit of output tends to reduce. In a
An situation when price is constant (as under perfect competition) this would mean a situation when the_
difference between the firm 's TR and TVC (Note that TVC = IMC) tends to increase. This means a
situation when firm's gross profit (TR - TVC) tends to rise. Why should a firm not increase output
when its gross profits are rising? Certainly it will. Therefore, it is only when MC is rising that the
firm will find its equilibrium output.
Q.2. What happens if the firm increases its output even when MR= MC?
Ant In asituation when MR = MC, any increase in output would mean MC> MR. This is because MR is
assumedto be constant (as under perfect competition) and (at the point of equilibrium) MC is rising.
It would be a situation when the difference between TR(= IMR) and TVC (= IMC) tends to reduce.
Or, that the firm's gross profits start red ucing.
Q.3. When price is constant for a firm (as under perfect competition) producer's equilibrium is
struck only when commodity price coincides with MC, and MC is rising. Do you agree?
Ans. Yes, it is true. In a situation when price is constant, AR = MR.' So that conditions of producer's
equilibrium may be written as:
(i) Price= MC, and (ii) MC is rising. ·
Q. ◄. Why should price (AR) be at least equal to average variable cost (AVC) for a firm to undertake
production? ·
·
· vanable
Ans. Thisisbecause a fi rm must cover at least its costs while · of a commoc:1·tty.
· un derta k'mg product1on
0

It would be totally an irrational act of the producer to get into a situation.when AR < AVC.
 · Equi·1·b
• Producers ·
1. num 1-,t:•rs
c.. to the ·situation of profit maximisation ·

. est1mat
• Pro fit s are • . ed as
.. the difference betWl't:'11 TR and TC, or the difference b"t
'" Ween l'R . ~
T\'C. ~nd

■ Economic Profits= TR - (Explicit Costs + Implicit Costs).

■ Accounting Profits = TR - Explicit Costs.

,,,~
,)
r

,~
■ Gross Profit= TR - TVC.

■ Net Profit = TR - TC. :J

■ Normal Profits: TR= TC (Normal profits are a part of TC). F
~
■ Abnormal Profits: TR> TC.

■ Sub-normal Profits (or Losses): TR < TC.

■ Three Necessary Conditions of Producer's Equilibrium are:

(i) MR= MC, (ii) MC is rising, and (iii) AR (price) ~ AVC.

■ Profits are Maximised only when MR = MC not when MR > MC or when MR < MC.
~~
■ Under Perfect Competition, Price (AR) = MR. Accordingly, profits are maximised only when a
price= MC, not when price< MC or when price > MC. 9

■ Under Perfect Competition, equilibrium is never struck when MC is falling. Because, given
'~1]
AR, falling MC increases the difference between TR and TVC (leading to higher and higher ~\
profits). m
ii
■ Profit Maximisation is a goal. It may not be achieved by all the fi rms and all the time. Some ~! J
firms run into losses, and may quit the market. However, quitting is possible only in the long ~
run.