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Equilibrium of firm under Perfect competition using MR and MC approach?
Wiki User
∙ 12y ago
Equilibrium of Firm: MR - MC Approach
Profit maximization is one of the important assumptions of economics. It is assumed that the entrepreneur always tries to maximize profit. Hence the firm or entrepreneur is said to be in equilibrium if the profit is maximized. According to Tibor Sitovosky "A market or an economy or any other group of persons and firms is in equilibrium when none of its member's fells impelled to change his behavior". Naturally, the firm will not try to change its position when it is in equilibrium by maximizing profit.
There are two approaches to explain the equilibrium of the firm regards to profit maximization. They are - total revenue-total cost approach and marginal revenue-marginal cost approach. Here we concentrate only on MR - MC approach.
The equilibrium of firm on the basis of MR - MC approach has been presented in the table below
According to MT -MC approach, when marginal revenue equals marginal cost the firm is in equilibrium and gets maximum profit. Hence, a rational producer determines the quality of output where marginal revenue equals marginal cost.
The difference between total revenue and total cost is highest 210, at four units of output. At this output, both marginal revenue and marginal cost are equal, 80. Hence profit is maximized. The firm is in equilibrium. It should be noted that the table relates to imperfect competition, when price is reduced to sell more.
The following two conditions are necessary for a firm to be in equilibrium.
(a) The marginal revenue should be equal to marginal cost.
(b) The marginal cost curve should cut marginal revenue curve from below.
The equilibrium of a under to MR - MC approach has been presented in figure:-
The figure depicts the equilibrium of a firm under perfect competition. The same is applicable to the firms under imperfect competition. The only difference is that the AR & MR curves under imperfect competition are different and they are downward sloping.
In the figure 'OP' is the given price. Since, under perfect competition, average revenue equals marginal revenue, the AR and MR curves are horizontal from P. The profit-maximizing output is OM. Here, marginal revenue and marginal cost are equal. It is because MC and MR curves intersect each other at point E. The firm earns profit equal to PEBC.
The first condition necessary for firm's equilibrium is that marginal cost should be equal to marginal revenue. But this is not a sufficient condition. It is because the firm may not be in equilibrium even if this condition is fulfilled. In the figure, this condition is fulfilled at point F. but the firm is not in equilibrium. The profit is maximized only at output OM which is higher than output ON.
The second condition necessary for equilibrium is that the marginal cost curve must cut marginal revenue curve from below. This implies that marginal cost should be rising at the point of intersection with MR curve. Hence, both the conditions have been fulfilled at point E. In the figure, MC curve cuts MR curve from at point F from above. Hence, this point cannot be the point of stable equilibrium. It is because before that point marginal cost exceeds marginal revenue. It shows that it is not reasonable to increase output. After point F, the MR curve lies above MC curve. This shows that it is reasonable to increase output.
Wiki User
∙ 12y ago
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